{"id":254219,"date":"2018-07-08T07:00:50","date_gmt":"2018-07-08T05:00:50","guid":{"rendered":"https:\/\/businesstech.co.za\/news\/?p=254219"},"modified":"2018-07-06T14:23:02","modified_gmt":"2018-07-06T12:23:02","slug":"how-to-get-the-most-out-of-compound-interest-and-one-thing-to-watch-out-for","status":"publish","type":"post","link":"https:\/\/businesstech.co.za\/news\/finance\/254219\/how-to-get-the-most-out-of-compound-interest-and-one-thing-to-watch-out-for\/","title":{"rendered":"How to get the most out of compound interest – and one thing to watch out for"},"content":{"rendered":"

Compound interest is a buzzword that many financial advisors mention when clients are looking to get the most out of their savings, with many financial products promising great returns – but things can also get confusing.<\/p>\n

According to\u00a0Neil Thompson, head of product at African Bank, it is up to service providers to make sure customers full understand how their interest-bearing products work, and which numbers to look at when comparing services.<\/p>\n

Generally, providers advertise the annual compounding<\/strong> interest rate<\/strong> on their offerings \u2013 the interest you earn as a depositor if you leave your deposit with the bank for a full year and only draw the interest at the end of that year.<\/p>\n

However, Thompson said it is easy to confuse this rate – which looks at compound interest over one year<\/strong> – with a ‘maturity’ or ‘expiry’ rate, which takes into account the compound interest earned over the entire deposit term<\/strong>.<\/p>\n

To illustrate the difference, the banking head looked at an example of a 10.5% rate for a fixed term deposit of 5 years. That is the annual compounding rate that you will earn if you decide to have interest paid out annually.<\/p>\n

Simply put, if you were to invest R100,000 in this 5-year fixed term product on 1 July 2018, the bank would pay you R10,500 in interest on 30 June 2019, and again on 30 June 2020, 30 June 2021, and 30 June 2022, and return the principle, together with the 5th year\u2019s interest on 30 June 2023, paying out a total of R110,500 on that date.<\/p>\n

In total you earn and are paid out interest of R52,500 (5 x R10 500).<\/p>\n

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Annual Compounding Interest<\/strong><\/p>\n

\n
\n\n\n\n\n\n\n\n\n
Year<\/th>\nOpen<\/th>\nInterest 10.5% per annum<\/th>\nPaid out<\/th>\nClose<\/th>\n<\/tr>\n
Year 1<\/td>\nR100 000<\/td>\nR10 500<\/td>\nR10 500<\/td>\nR100 000<\/td>\n<\/tr>\n
Year 2<\/td>\nR100 000<\/td>\nR10 500<\/td>\nR10 500<\/td>\nR100 000<\/td>\n<\/tr>\n
Year 3<\/td>\nR100 000<\/td>\nR10 500<\/td>\nR10 500<\/td>\nR100 000<\/td>\n<\/tr>\n
Year 4<\/td>\nR100 000<\/td>\nR10 500<\/td>\nR10 500<\/td>\nR100 000<\/td>\n<\/tr>\n
Year 5<\/td>\nR100 000<\/td>\nR10 500<\/td>\nR110 500<\/td>\nR0<\/td>\n<\/tr>\n
Total<\/strong><\/td>\n<\/td>\nR52 500<\/strong><\/td>\nR152 500<\/strong><\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table><\/div>\n<\/div>\n
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However, looking at the expiry rate<\/strong>, this is a higher rate that is earned by not having your bank pay you the interest on an annual basis<\/strong>, but by having the interest paid out on maturity<\/strong> of the product after 5 years.<\/p>\n

You may think the same R52,500 as above will be paid out after 5 years, which together with the return of the original principal, would result in a total pay-out of R152,500 on 30 June 2023 – however, the reality is that the total payout will be much higher.<\/p>\n

“The reason for this is compounding – or earning interest on interest,” Thompson said.<\/p>\n

“When we don\u2019t have our interest paid out by the bank, it is effectively re-invested and earns interest again at the annual compounding rate. Under this scenario the customer earns an additional amount of over R12,000, resulting in total interest earned of over R64,000 at an ‘expiry rate’ of 12.95%.”<\/p>\n

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Annual Compounding Interest at Expiry\/Maturity<\/strong><\/p>\n

\n
\n\n\n\n\n\n\n\n\n
Year<\/th>\nOpen<\/th>\nInterest 10.5% per annum<\/th>\nPaid out<\/th>\nClose<\/th>\n<\/tr>\n
Year 1<\/td>\nR100 000<\/td>\nR10 500<\/td>\nR0<\/td>\nR110 500<\/td>\n<\/tr>\n
Year 2<\/td>\nR110 500<\/td>\nR11 603<\/td>\nR0<\/td>\nR122 103<\/td>\n<\/tr>\n
Year 3<\/td>\nR122 103<\/td>\nR12 821<\/td>\nR0<\/td>\nR134 923<\/td>\n<\/tr>\n
Year 4<\/td>\nR134 923<\/td>\nR14 167<\/td>\nR0<\/td>\nR149 090<\/td>\n<\/tr>\n
Year 5<\/td>\nR149 090<\/td>\nR15 654<\/td>\nR164 745<\/td>\nR0<\/td>\n<\/tr>\n
Total<\/strong><\/td>\n<\/td>\nR64 745<\/strong><\/td>\nR164 745<\/strong><\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table><\/div>\n<\/div>\n
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According to Thompson, to get the most out of compound interest, you should look at the following:<\/p>\n