The power of compound interest to build wealth

The Advertiser

03-08-2025

"You've long promoted the power of compounding, but frankly, I don't see the point. If it just means letting bank interest build up - and nearly half gets lost to tax - surely there are better strategies. Am I missing something?"
Let's start with the maths: the Rule of 72. This simple rule tells you how long it takes for your money to double: divide 72 by your expected rate of return. If I have $100,000 earning 8 per cent, it will double every nine years. But if I leave it in the bank and earn just 3 per cent after tax, it will take 24 years to double. So your rate of return is vital.
And the other crucial bit? Time: every time your money doubles, the final doubling adds more than all the earlier ones put together. Let's say you start with $100,000 earning 8 per cent. After nine years, it's $200,000. After 18 years, $400,000. Then $800,000 after 27 years-and by year 36, it's grown to $1.6 million. That's the magic of compounding.
Now think about the person who just parks their money in the bank at 3 per cent. It takes 24 years to reach $200,000, and 48 years to get to $400,000. Meanwhile, the long-term investor is sitting on $4 million. These examples highlight just how vital both time and rate of return are.
Let's dig a little deeper. Compounding simply means reinvesting your earnings instead of spending them. Take a share portfolio returning 9 per cent - 5 per cent from capital growth and 4 per cent from income. The investor who reinvests everything will enjoy the full 9 per cent, meaning their portfolio doubles every eight years. But the one who spends the dividends captures only the 5 per cent growth component, and their money doubles only every 14 years.
So, to answer the email: compounding absolutely works, but it would be a mug's game to leave it sitting in the bank earning a pittance, especially after inflation and tax have taken their slice.
CASE STUDY Jack and Jill are both 25 and earning $65,000 a year. Each has employer super contributions of 12 per cent. Jill is money-smart and ensures her super is invested in a high-growth option to maximise returns. Jack loves betting on the footy and doesn't think much about super. He leaves his funds in the default investment. As a result, his fund earns just 4 per cent a year. Fast-forward 40 years: Jill's super has grown to around $3.3 million; Jack's is just $1.3 million.
That's a dramatic example of the power of compounding. Failing to use it to the maximum cost Jack $2 million. It's the difference between a comfortable retirement and one spent counting pennies.
And compounding is just as important in retirement as it is while you're building wealth. Not only does the rate of return determine how much you retire with, it also dictates how long it lasts.
Picture someone who retires at 65 with $1 million in super and plans to draw $60,000 a year, indexed. If their portfolio earns 8 per cent, the money will last until age 99. But if they play it too safe and earn just 4 per cent, they'll run out of funds by age 82 - and may have to rely entirely on the age pension.
Understanding compounding doesn't just help with investing, it's also crucial when borrowing. I'll explore that in another column soon.
Question: I'm a self-funded retiree with more money than I need to support my chosen lifestyle. I would like to gift $30,000 to each of my four sisters, all of whom are in their 70s. They're on a full pension, have minimal savings, and either rent or carry a small mortgage.
Will these gifts affect their Centrelink age pension entitlements?
Answer: Given they have minimal savings and no substantial assets, I cannot see how a gift could affect their age pension. I think it's great that you're doing something which can change peoples lives.
Question: I have three adult children and would like each to receive one-third of my estate under my will. If I nominate my personal legal representative (the executor of my estate) as the beneficiary of my super, will this be as effective in minimising the superannuation death tax as the recontribution strategy-without the added complexity? It certainly appears to be more straightforward.
Answer: The death tax on superannuation-15 per cent plus the Medicare levy-applies to the taxable component of your super when left to a non-dependent. If paid through your estate, the Medicare levy doesn't apply, but the 15 per cent death tax still does.
The recontribution strategy-where someone under 75 withdraws a large amount from super and re-contributes it as a tax-free component-can reduce the taxable portion. But it's no cure-all. You can't select which component is withdrawn, and unless you withdraw the full balance and re-contribute, some taxable component will remain and grow with earnings.
Also, once your balance exceeds $1.9 million or you turn 75, contributions are no longer allowed. In my view, the better strategy is to instruct your attorney to withdraw all super tax-free when death is near and transfer it to your bank account. That's the only way to completely eliminate the taxable component.
Question: I'm 55 and about to leave my employer permanently. My superannuation preservation age is 60. Fortunately, I have enough investment income to retire now and don't intend to return to the workforce. Once I turn 60, I plan to access my super. However, the ATO states that "you can withdraw your super when you reach your preservation age and retire," which seems to suggest that retirement must occur after age 60. If I've already left work before turning 60, will I still meet the condition of release once I reach 60?
Answer: Yes, you will satisfy the condition of release once you turn 60, provided you have genuinely retired and have no intention of returning to the workforce. The rules distinguish between retiring before 60 and retiring after 60, but in your case the key factor is your status and intention at age 60. Although you will have ceased work before reaching your preservation age, once you turn 60, you can access your superannuation on the basis that you are retired and have no plan to return to gainful employment. There is no requirement that you must actually leave work after your 60th birthday. As long as you are over 60 and not working, the retirement condition of release is met.
"You've long promoted the power of compounding, but frankly, I don't see the point. If it just means letting bank interest build up - and nearly half gets lost to tax - surely there are better strategies. Am I missing something?"
Let's start with the maths: the Rule of 72. This simple rule tells you how long it takes for your money to double: divide 72 by your expected rate of return. If I have $100,000 earning 8 per cent, it will double every nine years. But if I leave it in the bank and earn just 3 per cent after tax, it will take 24 years to double. So your rate of return is vital.
And the other crucial bit? Time: every time your money doubles, the final doubling adds more than all the earlier ones put together. Let's say you start with $100,000 earning 8 per cent. After nine years, it's $200,000. After 18 years, $400,000. Then $800,000 after 27 years-and by year 36, it's grown to $1.6 million. That's the magic of compounding.
Now think about the person who just parks their money in the bank at 3 per cent. It takes 24 years to reach $200,000, and 48 years to get to $400,000. Meanwhile, the long-term investor is sitting on $4 million. These examples highlight just how vital both time and rate of return are.
Let's dig a little deeper. Compounding simply means reinvesting your earnings instead of spending them. Take a share portfolio returning 9 per cent - 5 per cent from capital growth and 4 per cent from income. The investor who reinvests everything will enjoy the full 9 per cent, meaning their portfolio doubles every eight years. But the one who spends the dividends captures only the 5 per cent growth component, and their money doubles only every 14 years.
So, to answer the email: compounding absolutely works, but it would be a mug's game to leave it sitting in the bank earning a pittance, especially after inflation and tax have taken their slice.
CASE STUDY Jack and Jill are both 25 and earning $65,000 a year. Each has employer super contributions of 12 per cent. Jill is money-smart and ensures her super is invested in a high-growth option to maximise returns. Jack loves betting on the footy and doesn't think much about super. He leaves his funds in the default investment. As a result, his fund earns just 4 per cent a year. Fast-forward 40 years: Jill's super has grown to around $3.3 million; Jack's is just $1.3 million.
That's a dramatic example of the power of compounding. Failing to use it to the maximum cost Jack $2 million. It's the difference between a comfortable retirement and one spent counting pennies.
And compounding is just as important in retirement as it is while you're building wealth. Not only does the rate of return determine how much you retire with, it also dictates how long it lasts.
Picture someone who retires at 65 with $1 million in super and plans to draw $60,000 a year, indexed. If their portfolio earns 8 per cent, the money will last until age 99. But if they play it too safe and earn just 4 per cent, they'll run out of funds by age 82 - and may have to rely entirely on the age pension.
Understanding compounding doesn't just help with investing, it's also crucial when borrowing. I'll explore that in another column soon.
Question: I'm a self-funded retiree with more money than I need to support my chosen lifestyle. I would like to gift $30,000 to each of my four sisters, all of whom are in their 70s. They're on a full pension, have minimal savings, and either rent or carry a small mortgage.
Will these gifts affect their Centrelink age pension entitlements?
Answer: Given they have minimal savings and no substantial assets, I cannot see how a gift could affect their age pension. I think it's great that you're doing something which can change peoples lives.
Question: I have three adult children and would like each to receive one-third of my estate under my will. If I nominate my personal legal representative (the executor of my estate) as the beneficiary of my super, will this be as effective in minimising the superannuation death tax as the recontribution strategy-without the added complexity? It certainly appears to be more straightforward.
Answer: The death tax on superannuation-15 per cent plus the Medicare levy-applies to the taxable component of your super when left to a non-dependent. If paid through your estate, the Medicare levy doesn't apply, but the 15 per cent death tax still does.
The recontribution strategy-where someone under 75 withdraws a large amount from super and re-contributes it as a tax-free component-can reduce the taxable portion. But it's no cure-all. You can't select which component is withdrawn, and unless you withdraw the full balance and re-contribute, some taxable component will remain and grow with earnings.
Also, once your balance exceeds $1.9 million or you turn 75, contributions are no longer allowed. In my view, the better strategy is to instruct your attorney to withdraw all super tax-free when death is near and transfer it to your bank account. That's the only way to completely eliminate the taxable component.
Question: I'm 55 and about to leave my employer permanently. My superannuation preservation age is 60. Fortunately, I have enough investment income to retire now and don't intend to return to the workforce. Once I turn 60, I plan to access my super. However, the ATO states that "you can withdraw your super when you reach your preservation age and retire," which seems to suggest that retirement must occur after age 60. If I've already left work before turning 60, will I still meet the condition of release once I reach 60?
Answer: Yes, you will satisfy the condition of release once you turn 60, provided you have genuinely retired and have no intention of returning to the workforce. The rules distinguish between retiring before 60 and retiring after 60, but in your case the key factor is your status and intention at age 60. Although you will have ceased work before reaching your preservation age, once you turn 60, you can access your superannuation on the basis that you are retired and have no plan to return to gainful employment. There is no requirement that you must actually leave work after your 60th birthday. As long as you are over 60 and not working, the retirement condition of release is met.
"You've long promoted the power of compounding, but frankly, I don't see the point. If it just means letting bank interest build up - and nearly half gets lost to tax - surely there are better strategies. Am I missing something?"
Let's start with the maths: the Rule of 72. This simple rule tells you how long it takes for your money to double: divide 72 by your expected rate of return. If I have $100,000 earning 8 per cent, it will double every nine years. But if I leave it in the bank and earn just 3 per cent after tax, it will take 24 years to double. So your rate of return is vital.
And the other crucial bit? Time: every time your money doubles, the final doubling adds more than all the earlier ones put together. Let's say you start with $100,000 earning 8 per cent. After nine years, it's $200,000. After 18 years, $400,000. Then $800,000 after 27 years-and by year 36, it's grown to $1.6 million. That's the magic of compounding.
Now think about the person who just parks their money in the bank at 3 per cent. It takes 24 years to reach $200,000, and 48 years to get to $400,000. Meanwhile, the long-term investor is sitting on $4 million. These examples highlight just how vital both time and rate of return are.
Let's dig a little deeper. Compounding simply means reinvesting your earnings instead of spending them. Take a share portfolio returning 9 per cent - 5 per cent from capital growth and 4 per cent from income. The investor who reinvests everything will enjoy the full 9 per cent, meaning their portfolio doubles every eight years. But the one who spends the dividends captures only the 5 per cent growth component, and their money doubles only every 14 years.
So, to answer the email: compounding absolutely works, but it would be a mug's game to leave it sitting in the bank earning a pittance, especially after inflation and tax have taken their slice.
CASE STUDY Jack and Jill are both 25 and earning $65,000 a year. Each has employer super contributions of 12 per cent. Jill is money-smart and ensures her super is invested in a high-growth option to maximise returns. Jack loves betting on the footy and doesn't think much about super. He leaves his funds in the default investment. As a result, his fund earns just 4 per cent a year. Fast-forward 40 years: Jill's super has grown to around $3.3 million; Jack's is just $1.3 million.
That's a dramatic example of the power of compounding. Failing to use it to the maximum cost Jack $2 million. It's the difference between a comfortable retirement and one spent counting pennies.
And compounding is just as important in retirement as it is while you're building wealth. Not only does the rate of return determine how much you retire with, it also dictates how long it lasts.
Picture someone who retires at 65 with $1 million in super and plans to draw $60,000 a year, indexed. If their portfolio earns 8 per cent, the money will last until age 99. But if they play it too safe and earn just 4 per cent, they'll run out of funds by age 82 - and may have to rely entirely on the age pension.
Understanding compounding doesn't just help with investing, it's also crucial when borrowing. I'll explore that in another column soon.
Question: I'm a self-funded retiree with more money than I need to support my chosen lifestyle. I would like to gift $30,000 to each of my four sisters, all of whom are in their 70s. They're on a full pension, have minimal savings, and either rent or carry a small mortgage.
Will these gifts affect their Centrelink age pension entitlements?
Answer: Given they have minimal savings and no substantial assets, I cannot see how a gift could affect their age pension. I think it's great that you're doing something which can change peoples lives.
Question: I have three adult children and would like each to receive one-third of my estate under my will. If I nominate my personal legal representative (the executor of my estate) as the beneficiary of my super, will this be as effective in minimising the superannuation death tax as the recontribution strategy-without the added complexity? It certainly appears to be more straightforward.
Answer: The death tax on superannuation-15 per cent plus the Medicare levy-applies to the taxable component of your super when left to a non-dependent. If paid through your estate, the Medicare levy doesn't apply, but the 15 per cent death tax still does.
The recontribution strategy-where someone under 75 withdraws a large amount from super and re-contributes it as a tax-free component-can reduce the taxable portion. But it's no cure-all. You can't select which component is withdrawn, and unless you withdraw the full balance and re-contribute, some taxable component will remain and grow with earnings.
Also, once your balance exceeds $1.9 million or you turn 75, contributions are no longer allowed. In my view, the better strategy is to instruct your attorney to withdraw all super tax-free when death is near and transfer it to your bank account. That's the only way to completely eliminate the taxable component.
Question: I'm 55 and about to leave my employer permanently. My superannuation preservation age is 60. Fortunately, I have enough investment income to retire now and don't intend to return to the workforce. Once I turn 60, I plan to access my super. However, the ATO states that "you can withdraw your super when you reach your preservation age and retire," which seems to suggest that retirement must occur after age 60. If I've already left work before turning 60, will I still meet the condition of release once I reach 60?
Answer: Yes, you will satisfy the condition of release once you turn 60, provided you have genuinely retired and have no intention of returning to the workforce. The rules distinguish between retiring before 60 and retiring after 60, but in your case the key factor is your status and intention at age 60. Although you will have ceased work before reaching your preservation age, once you turn 60, you can access your superannuation on the basis that you are retired and have no plan to return to gainful employment. There is no requirement that you must actually leave work after your 60th birthday. As long as you are over 60 and not working, the retirement condition of release is met.
"You've long promoted the power of compounding, but frankly, I don't see the point. If it just means letting bank interest build up - and nearly half gets lost to tax - surely there are better strategies. Am I missing something?"
Let's start with the maths: the Rule of 72. This simple rule tells you how long it takes for your money to double: divide 72 by your expected rate of return. If I have $100,000 earning 8 per cent, it will double every nine years. But if I leave it in the bank and earn just 3 per cent after tax, it will take 24 years to double. So your rate of return is vital.
And the other crucial bit? Time: every time your money doubles, the final doubling adds more than all the earlier ones put together. Let's say you start with $100,000 earning 8 per cent. After nine years, it's $200,000. After 18 years, $400,000. Then $800,000 after 27 years-and by year 36, it's grown to $1.6 million. That's the magic of compounding.
Now think about the person who just parks their money in the bank at 3 per cent. It takes 24 years to reach $200,000, and 48 years to get to $400,000. Meanwhile, the long-term investor is sitting on $4 million. These examples highlight just how vital both time and rate of return are.
Let's dig a little deeper. Compounding simply means reinvesting your earnings instead of spending them. Take a share portfolio returning 9 per cent - 5 per cent from capital growth and 4 per cent from income. The investor who reinvests everything will enjoy the full 9 per cent, meaning their portfolio doubles every eight years. But the one who spends the dividends captures only the 5 per cent growth component, and their money doubles only every 14 years.
So, to answer the email: compounding absolutely works, but it would be a mug's game to leave it sitting in the bank earning a pittance, especially after inflation and tax have taken their slice.
CASE STUDY Jack and Jill are both 25 and earning $65,000 a year. Each has employer super contributions of 12 per cent. Jill is money-smart and ensures her super is invested in a high-growth option to maximise returns. Jack loves betting on the footy and doesn't think much about super. He leaves his funds in the default investment. As a result, his fund earns just 4 per cent a year. Fast-forward 40 years: Jill's super has grown to around $3.3 million; Jack's is just $1.3 million.
That's a dramatic example of the power of compounding. Failing to use it to the maximum cost Jack $2 million. It's the difference between a comfortable retirement and one spent counting pennies.
And compounding is just as important in retirement as it is while you're building wealth. Not only does the rate of return determine how much you retire with, it also dictates how long it lasts.
Picture someone who retires at 65 with $1 million in super and plans to draw $60,000 a year, indexed. If their portfolio earns 8 per cent, the money will last until age 99. But if they play it too safe and earn just 4 per cent, they'll run out of funds by age 82 - and may have to rely entirely on the age pension.
Understanding compounding doesn't just help with investing, it's also crucial when borrowing. I'll explore that in another column soon.
Question: I'm a self-funded retiree with more money than I need to support my chosen lifestyle. I would like to gift $30,000 to each of my four sisters, all of whom are in their 70s. They're on a full pension, have minimal savings, and either rent or carry a small mortgage.
Will these gifts affect their Centrelink age pension entitlements?
Answer: Given they have minimal savings and no substantial assets, I cannot see how a gift could affect their age pension. I think it's great that you're doing something which can change peoples lives.
Question: I have three adult children and would like each to receive one-third of my estate under my will. If I nominate my personal legal representative (the executor of my estate) as the beneficiary of my super, will this be as effective in minimising the superannuation death tax as the recontribution strategy-without the added complexity? It certainly appears to be more straightforward.
Answer: The death tax on superannuation-15 per cent plus the Medicare levy-applies to the taxable component of your super when left to a non-dependent. If paid through your estate, the Medicare levy doesn't apply, but the 15 per cent death tax still does.
The recontribution strategy-where someone under 75 withdraws a large amount from super and re-contributes it as a tax-free component-can reduce the taxable portion. But it's no cure-all. You can't select which component is withdrawn, and unless you withdraw the full balance and re-contribute, some taxable component will remain and grow with earnings.
Also, once your balance exceeds $1.9 million or you turn 75, contributions are no longer allowed. In my view, the better strategy is to instruct your attorney to withdraw all super tax-free when death is near and transfer it to your bank account. That's the only way to completely eliminate the taxable component.
Question: I'm 55 and about to leave my employer permanently. My superannuation preservation age is 60. Fortunately, I have enough investment income to retire now and don't intend to return to the workforce. Once I turn 60, I plan to access my super. However, the ATO states that "you can withdraw your super when you reach your preservation age and retire," which seems to suggest that retirement must occur after age 60. If I've already left work before turning 60, will I still meet the condition of release once I reach 60?
Answer: Yes, you will satisfy the condition of release once you turn 60, provided you have genuinely retired and have no intention of returning to the workforce. The rules distinguish between retiring before 60 and retiring after 60, but in your case the key factor is your status and intention at age 60. Although you will have ceased work before reaching your preservation age, once you turn 60, you can access your superannuation on the basis that you are retired and have no plan to return to gainful employment. There is no requirement that you must actually leave work after your 60th birthday. As long as you are over 60 and not working, the retirement condition of release is met.