Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 86

Set yourself to benefit from compounding

Recently I wrote that a person aged 25 and earning $35,000 a year may accumulate $4 million in superannuation at age 65 just by relying on the employer compulsory contribution.

This resulted a flood of emails asking if I had made a mistake in the calculations as the outcome seemed too good to be true.

There was no mistake – it was just compound interest doing its work. To put it simply, how much you will have at the end of a given period depends on the time the money is invested and the rate you can achieve. If the term is short, the rate matters little, but as time lengthens it matters enormously.

To get an estimate of how much a 25-year-old could expect at age 65 we need to make certain assumptions. They are the rate of growth of salary, inflation, and a reasonable earning rate. In the example, I assumed inflation was 3% per annum, wages growth was 4% per annum, and the rate of return was inflation plus 7% (historically reasonable but perhaps a tad optimistic now). This gives a nominal return of 10% per annum. I also assumed the employer contribution would rise to 12% by 2020.

An important step for understanding the buying power of the $4 million is to convert those future dollars to today’s dollars. If inflation was 3% per annum, $4 million in 40 years would have a value of just $1,212,000 in today’s dollars. Yes, still a hefty sum, but doesn't sound nearly as much as $4 million.

Massive impact of term and earning rate

The big lesson here is the way the rate and the duration of the investment dramatically affect the end balance. Suppose a person invested $1,000 a month towards their retirement. If they started at 25 they would have $6.3 million at age 65 if they could achieve 10% per annum. However, the final sum would be just $2 million if they only achieved 6% per annum.

If a person waited until they were 45 to start the programme, and still managed to invest $1,000 a month they may have $760,000 at 10% and $462,000 at 6%. Because the term is much shorter the lower earning rate does not have such a dramatic effect.

The importance of getting the best return on your superannuation is particularly important now that employer contributions are not going to increase as fast as originally planned.  Recently the media have been focusing on the effect a reduction in the employer contribution would have on their final balance, but it’s small bikkies in the scheme of things. For a person earning $80,000 a year the net employer contribution after the 15% entry tax would be $6,460 at 9.5% of salary and $8,160 at 12% of salary. The difference is just $1700 a year.

Engage with your super early

I regularly receive emails from young people whose superannuation is all in the capital stable or balanced area. This is inappropriate for anybody under 50. To make matters worse the majority of SMSFs have no exposure to international funds at all. Obviously the trustees have never bothered to check out funds like Magellan (Global Fund) and Platinum (International Fund), which have strong track records of delivering good returns.

A major finding of the Cooper Review into superannuation was that 80% of Australians were ‘disengaged with their super’. If you find yourselves in that 80%, my advice to you is to start to get engaged. You've just seen how a small difference in the rate of return or starting earlier can make a huge difference to the amount you will have when you retire.


Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. His website is

October 31, 2014

That humanity needs to be reminded time and again about compound interest is a telling commentary on our collective ability to ignore the basics. Like gravity, compounding works its impact in an agnostic way - just as Noel points out the merits of compounding when you are a saver, the downside when you are a borrower and allow interest to accumulate is equally relentless. The disengaged, the negligent, the downright careless and the unfortunates fallen on hard times find this to their personal and family cost.

We have successfully transformed our inability into extreme forms of reaction, including pejoratives such as 'usury'.

On the practical side, deposit-takers and lenders have arrogated to themselves the mathematical consequences of compounding: thus a five year compounded deposit boasts of a stellar equivalent simple interest rate achieved, forgetting that each interest instalment has also been deposited till residual maturity. Equally, the interest 'saved' by borrower by increasing the frequency of repayment is often advertised almost as if the lender is doing a favour. It would help to remember that the ultimate saving of interest is achieved by making the principal or duration zero: don't borrow, or repay on the date of borrowing!

Something many find revealing is compound growth is more natural than simple rate of growth. If we accept that something will grow by a set percentage at a defined frequency, it must follow that the new growth will also grow likewise. Simple rate of growth denies further growth to the new offshoot, and is hence artificial. Think of a small plant, and this will dawn on us.


Leave a Comment:



Let’s talk more about compounding and the Rule of 72

Compound interest rewards patience in an impatient world

The most amazing investing lesson of all


Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates


$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reason to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies will benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.


Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated investors' can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.