When it comes to retirement planning, many people perceive it as something far off, believing they have plenty of time to prepare. However, as they approach retirement age, many regret not starting earlier.
To prepare adequately for retirement, it is crucial to start early, especially in the financial aspect. By doing so, you not only have sufficient time to prepare and address your retirement needs, but your savings will also benefit from compound interest, allowing them to grow significantly over time.
What is compound interest?
Compound interest might not be a familiar term for most of the people on the street. Chances are that many people have heard of it but are not sure how it works. According to the OECD/INFE 2023 International Survey of Adult Financial Literacy, only 2 in 5 Malaysians answered correctly on the questions on compound interest calculation.
Described as the eighth wonder of the world, compound interest is a method used to grow your money effortlessly. It is a powerful mechanism as you continue to earn interests on top of the previous interests earned, compounding your initial amount over time. In simple terms, we can describe this method as ‘money makes money.’
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What are the benefits of compound interest?
There are three key factors that play significant roles to maximise the benefits of compound interest: time, the amount of interests or dividend earned, and the amount invested or saved. Of these, time plays a significant role, especially for long-term goals like retirement savings, as it amplifies the compounding effect of returns.
To illustrate the impact of time in compounding, consider the two following scenarios.
Ahmad starts saving at age 20, contributing RM200 every month. He maintains this commitment consistently for 40 years until age 60 and makes no withdrawals throughout this period. By age 60, Ahmad has accumulated approximately RM305,000.
Disclaimer: Calculation is based on an estimated interest rate of 5%; consistent savings and no withdrawals made. This is for illustrative purposes and the actual dividend calculation method differs.
On the other hand, Diana begins saving later at age 40 and contributes RM400 every month. By age 60, she only manages to accumulate approximately RM164,000.
Compared to Diana, Ahmad accumulates more savings because he started saving at an earlier age, allowing his savings a longer duration to benefit from compounding. Even though Diana saves more each month, she cannot accumulate as much as Ahmad as she started to save later.
This example shows that starting to save at an earlier age will generate more savings than starting later.
3 tips to reap the benefits of compound interest
1) Start saving early
Practicing saving at a young age will help you generate more savings over time, as your money will have more time to compound. The longer you save, the more you will be able to accumulate. Do allocate a portion of your income for savings as soon as you start working.
Tip: Many individuals begin planning for retirement only later in life, which leaves them with a limited timeframe to prepare adequately. Start preparing for your retirement today if you have yet to do so. You can now top up your EPF savings at your fingertips via the KWSP i-Akaun app. Let’s boost your savings for a meaningful retirement.
2) Make consistent savings a priority in your finances
Plan your savings and treat them as an important part of your financial management. Make sure your savings are consistent and use recurring methods to avoid missing any payment. Consistency in savings helps to reap more benefits from compounding.
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3) No withdrawal of interest
Ensure that the interest or dividends earned each year remain in your savings and are not withdrawn, allowing them to continue generating returns. This will help your savings grow significantly. In cases where you need to make withdrawals, pace them carefully to ensure your remaining savings can continue earning interest. Gradual and controlled withdrawals help extend the life of your savings, whereas early and excessive withdrawals can rapidly diminish the savings accumulated.