Compound interest effect

The lessons a snowball can teach us about long-term asset growth

A snowball rolling down a hill will get bigger and bigger. The same thing happens to assets with long-term financial investment. And what’s the secret behind this? The compound interest effect.

The current market situation means that nowadays savings accounts barely generate any interest at all. You have a higher chance of better returns with investment funds. Even with small amounts, there is big savings potential. This is because time does a lot of the work and compound interest ensures that the amount saved increases disproportionately. The compound interest effect follows the principle that the longer a financial investment runs, the more strength the compound interest releases.

A 35-year-old who invests CHF 200 a month at 4% over 30 years will have pension fund assets of almost CHF 140,000 by the time he or she is 65. If the saving plan began when that person was 25, he or she would receive almost CHF 100,000 more, having paid in only an additional CHF 24,000. The ten extra years of saving create extra interest of around CHF 70,000.

A longer saving period increases profits. This means that the shorter the saving period, the less you feel the compound interest effect. If a 45-year-old has only 20 years to build up his or her capital, with the same saving rate he will end up with only a third of the final capital of a 25-year-old. To achieve the same savings assets, the 45-year-old would have to set aside more than three times as much every month, almost CHF 650. Investors who start saving earlier can make compound interest work better for them. They also have smaller monthly instalments and can enjoy greater savings potential.

This might interest you too