How compound interest can make you rich
It’s been a key to unlocking great wealth for decades, and while interest rates are still ultra-low, Anthony Keane explains how it can still generate you cash if you know where to use it.
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OPINION: Compound interest is sometimes described as the eighth wonder of the world, but in these days of ultra-low interest rates it’s looking a lot less wondrous.
The idea of earning interest on your interest on your interest, and so on, to multiply your wealth loses impact when interest currently paid on many bank deposits is almost zero.
Banks and other financial institutions continue to slash deposit account interest rates, with the best available return on your at-call cash now just 1.65 per cent and the big four banks averaging less than 0.4 per cent.
But before you chuck out compound interest as a tool, it’s wise to know where it does still work.
SHARES
Aussie share dividends are paying an average income of about 3.5 per cent, which is more than twice as much as bank deposits.
If you reinvest those dividends and let them compound over a decade it still delivers a nice gain.
According to ASIC’s moneysmart.gov.au compound interest calculator, interest on a $10,000 cash deposit earning a competitive rate (by today’s standards) of 1.5 per cent will grow your money to $11,617 after decade.
But if it’s in a share portfolio earning 3.5 per cent, the dividends alone grow to $14,183, and that doesn’t include any capital growth by the company.
Most shares also give you a 30c in the dollar tax credit because of dividend franking.
There are several major stocks with dividend yields above 6 per cent right now including Fortescue Metals Group, AGL Energy, Woodside Petroleum, Westpac, NAB and shopping mall owner Scentre Group.
For the record, $10,000 of shares with compounding dividends at 6 per cent climbs above $18,000 in a decade.
When investing in shares, diversify your holdings across different companies and sectors.
REAL ESTATE
Rent paid to property investors is income just like dividends and deposits. Adelaide’s current rental yield is 4.2 per cent for houses and 5.3 per cent for units, according to CoreLogic data.
Many landlords use the rent they receive to pay the interest on their investment loans, but once that’s down or paid off completely – rental income creates compound interest cream.
SUPERANNUATION
Your super is not technically an investment – it’s a structure that holds many different investments such as shares, real estate, infrastructure, bonds and cash.
Both balanced and growth super fund returns have averaged at least 7 per cent annually for the past seven and 10 years, even when you include their sub-1 per cent growth in the past year caused by the pandemic.
Superannuation returns compound over many decades, and also benefit from compulsory employer contributions buying more assets for you throughout the year.
DEBT HELP
While COVID cuts to interest rates have crunched deposits, borrowers have benefited beautifully.
People who borrow invest can now pay less on their loans while their investments can deliver income and growth above their interest cost.
And if you want to repay any loan faster to save interest in the long term, making extra repayments in this low-rate environment is a certain winner.