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Compound interest

Q. I heard you talking to an economist on your television program called Don Stammer who kept talking about the ‘magic of compound interest’. What exactly is he talking about?

A. Don Stammer was the former chief economist of Deutsche Bank in Australia. He has some simple rules about investing that say buy great blue chip companies, hold them and the magic of compound interest will look after you. This relates to the snowball effect of investing and receiving returns — dividends — and reinvesting them into the companies and, like in a casino, you let it ride.

A. Don says shares will return around say 12% per annum and if you use the Rule of 72 that means your money will double every six years. Maths geeks have proven if you take a certain interest rate or return of say 6% and divide it into 72 your money will double every 12 years. It happens by the compounding effect over time and that’s why people like Don call themselves long-term investors.

Imagine you put $50,000 into shares and your return averaged 12% then your money would grow like this: $100,000 after six years, $200,000 after 12 years, $400,000 after 18 years and so on. This is a simple example, as tax has to be factored in and you might not average 12%, it might be 8% and so your money would double every nine years. However, you get the principle of buying, holding, re-investing and letting the magic of compound interest do the rest. 

 

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

 

Published on: Tuesday, October 20, 2009

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