FAMOUS 18TH CENTURY American statesman Benjamin Franklin is credited with the adage “time is money”.
This simple expression draws attention to the fact that $100 today is worth more a year later due to the earning ability of that sum over the period. Another way of recognizing that “time is money” is noticing that every job or service takes time and payment is often based on the time spent.
Today we will consider examples of how compound interest can make time and money work for us.
If you were to save $100 per month and invest it in a fund at the end of each year for 25 years, earning five per cent interest per annum compounded, instead of having the $30 000 that you would have put into the fund, the fund would be worth $46 206 after that 25-year period.
If you were to just leave the fund invested at the same rate and never add another penny to it, at the end of another 40 years, it would be worth $325 292. The passage of time, a long time, would have converted your modest saving into a grand sum.
These amounts and period of time have been used to show a way that a grandparent may possibly set aside an inheritance or trust/pension fund for a grandchild without excessive strain.
Had the same grandparent earlier saved $200 per month for a 20-year period, say from age 20 to 40 years old, at five per cent interest compounded and never added any more money to their personal fund after age 40, by age 65, normal retirement age, the fund would be worth $268 735. The absolute amount of money placed in the fund would only have been $48 000.
By now I hope you would have worked out that this one grandparent could have reasonably done both these investments – taking care of their own fund between 20 and 40 years old and setting aside for not one but two grandchildren between 40 and 65 years old!
The earlier one starts on a saving and investing programme, the better will be the outcome. Time is one’s best ally; it allows your money to work for you in the interim.
The higher the interest rate that you can earn on your investment fund, the quicker it will balloon to a grand sum. For example, if it was possible to earn an interest rate of eight per cent per annum compounded over the periods involved, the child’s inheritance would have grown to over a million dollars – $1 445 726. The grandparent personal fund would have grown to $753 159. Is that not worth considering?
The converse is also true, the later you start to save and invest, and the lower the interest rate earned, the more difficult it will be to accumulate a substantial fund.
Typically, though, the higher the interest rate earned, the greater the risk that interest earned and sometimes the principal invested may be eroded. Should one meet with financial disaster late in one’s work career, there is little time to recover.
If we each had a good idea of how long we would live, that would be a great help. We would know how much to put aside, for how long, and how much time is worthy of working/earning. That is the enigma of life. Although time is money and in many ways it will remain so, our planning will still have to rely on our best judgment. In that way, this famous adage will still turn out to mean different things for different people.
• Louise Fairsave is a personal financial management advisor, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances.