The notion of having a million dollars has always ignited people’s imaginations. It used to be because it signified something rare of unachievable, like being a millionaire or winning a large sum of money of a television game show.
But now it’s an amount of money that seems to be more necessary than imaginary, what with many middle-class homes costing upwards of a million dollars or that same sum being the minimum you need to leave behind when you die or to retire with.
The problem is, what is now increasingly part of our reality is no easier to achieve in the present moment. For many of us, the idea of saving S$1 million seems unlikely, especially with our current financial burdens, exacerbated by rising costs of living.
Fortunately, the magic of compound interest still holds true.
Of cupcakes and compound interest
Let’s talk about compound interest in the form of a fairy tale.
Once upon a time, there was a thirtysomething woman called Cinderlian who was given a dozen cupcakes. She was very happy with them and showed them off to her fairy godmother.
“What lovely cupcakes!” said the fairy godmother. “If you like, I can use my magic powers and turn them into more cupcakes. But you must leave them with me for 20 years. For every year that you leave them with me, I will add more cupcakes to your stash.”
Cinderlian loved and trusted her fairy godmother. She was also very kiasu and afraid of getting fat so she only ate two cupcakes and left the rest with her fairy godmother.
20 years later she returned to her fairy godmother. True enough, her cupcakes had multiplied to fill many cupcake stands! She was able to throw a retirement party and have some left over to trade for other nice things (like a nice Prada bag because they were very nice cupcakes).
Everyone was happy.
Wait a minute, you must be thinking “what do you mean ‘The End’”?! Like, what did the fairy godmother do to get Cinderlian from 10 cupcakes to a whopping amount to fill many cupcake stands right?
Well, magic of course (remember she’s a fairy?). Except, we’re not really talking about cupcakes are we? We’re talking about something of value that is put away and through time and something “special”, becomes more than its original sum.
Yes, we’re talking about the magic of compound interest that happens to your money when you put it in a regular savings or investment plan.
But what’s compound interest and how does it work?
The word “compound” used here just means “accumulated” and interest is well, a sum of money that is regularly paid. So “compound interest” is just “accumulated sums of money” or earning interest on interest.
And the reason why so many people are interested (heh, pardon the pun) in compound interest is because they want to take the initial sum of money they have, put it away in financial products they trust and let it grow over time – very much like how Cinderlian entrusted her cupcakes with her fairy godmother.
Let’s apply compound interest to actual money. If you have some cash to spare, say S$10,000, here’s how much it can grow, assuming an interest rate of 6% per annum.
You have a principle sum of S$10,000.
You earn 6% interest, which is S$600.
That gives you S$10,600 at the end of the year.
The interest you earned last year is added to your principle sum, so you now have S$10,600.
You earn 6% interest on this amount, which is S$636.
That gives you S$11,236 at the end of the year.
The interest earned in the previous year is again added to your principle sum, so you now have S$11,236.
You earn 6% interest on this amount, which is S$674.16
.That gives you S$11,910.16 at the end of the year.
This goes on. Essentially, the interest you earn each year is also accumulating interest. At the end of Year 10, your initial S$10,000 would have snowballed to S$17,908.48! That’s close to double what you originally put in!
If it’s S$1 million that you want, here’s what the Maths looks like…
What you need to put in: S$1,022 per month X 360 months (30 years) = $368,000
What you’ll get back: Assuming your money grows at 6% interest per annum, at the end of 30 years, you’d have accumulated a little over S$1,000,000.
Your money would have tripled. Now that’s just magical.