Smash that Piggy Bank (Part 2)

Compound Interest – Earn it & Don’t Pay for it

In Part 1 of Smash that Piggy Bank, I shared how receiving a Piggy Bank as a gift on my 7th birthday created a bad money habit.  I spent money freely and only saved what I had left.  This was often very little and sometimes nothing at all. 

What I should have been doing was to save first and then spend.

This bad money habit did not go unnoticed by my Mother.  On my 8th, she taught me an important financial education lesson.

The Discovery of the Eighth Wonder of the World; Compound Interest.

My mother told me that on my eighth birthday she was going to give me a special gift that would make money.

I had been enchanted by the stories that she had told me about the Seven Wonders of the Ancient World.  I imagined that she was going to give me something like Aladdin’s lamp that I could rub and “hey, presto!” gold coins would drop into my hand.

My mother did not give me Aladdin’s lamp however. 

She gave me a little red bank book.  Turning to the first page, I saw that there had already been a deposit in my new Savings Account.  The princely sum of £12.  Times that by 10 and you have an idea of what that is worth today.  But the story she then told me was infinitely more valuable.

“Your Money will Grow while you Sleep,” she said.

“How much would you have in your Piggy Bank on your ninth birthday, a year from now, if you put in £12 today and leave it?”

Even I could answer that one.

“£12, of course,” I replied.

“Correct.  But if you leave this £12 in your new Savings Account until your ninth birthday, it will grow to £13.20.  And if you don’t touch it for another year, it will grow to £14.52.  Within 8 years, your original £12 will have more than doubled to £25.72.  Your money will grow while you sleep,” she said.

That level of interest rate on a Savings Account deposit may sound like Jack and the Beanstalk magic, but interest rates really were that high back then.

The principle of this story is simple. 

The longer that I left my £12 in the Savings Account without touching it, the greater the benefit from the year on year compound growth.  Not only would I get interest on the original £12, but I would get interest on top of interest and my money would grow. 

The power of compound interest can transform even small sums.  And it will benefit you if you start the journey now, as the aim is to make your money grow over the long term

Beware! Compound Interest can be your enemy

You might be inclined to borrow money on a credit card in order to buy something now and pay off later,  and you could end up paying 20% interest.  So, by paying that interest, compounding is now working against you, rather than to your advantage. 

That is not to say that you should never use debt.  But when debt is not used wisely, it can create more problems.

Albert Einstein called compound interest the Eighth Wonder of the World.  He who understands it, earns it.  He who doesn’t, pays it.  Don’t let it be you who pays it!

A blog post by Philip Robinson

Philip is a Senior Wealth Manager at Mardon Financial Advisers Ltd and an Education Champion on the My Personal Finance Skills programme delivering free workshops in schools/colleges.

Views expressed above are his own and do not constitute advice

For more on the above and other money subjects, check out the Your Money Matters here.