Have you ever heard of compound interest? Well, when it comes to your KiwiSaver investment, compound returns work in much the same way.
What is compound interest?
Compound interest is like a snowball rolling down a hill, gathering more snow and growing larger as it goes. In financial terms, it means you earn interest on your initial savings, and then you earn interest on both your original savings and the interest you’ve already earned. Over time, this compounding interest-on-interest effect can lead to substantial growth in your investment.
With your KiwiSaver account, you earn returns on your investment. This can be through things like interest, capital gains or dividends. Compounding occurs when these returns get re-invested. In short, the returns you earn also earn a return, effectively making you more money!
Understanding and benefiting from the power of compounding returns can significantly boost your KiwiSaver investment, helping you secure a comfortable retirement or getting you into your first home. Let's explore how this works and why it’s such a game-changer for your future savings.
How does compounding work with KiwiSaver?
- Initial Contributions: When you start making contributions to your KiwiSaver account, you’re starting with the initial seeds of growth that will grow over time.
- Earning returns: Your contributions then generate investment returns adding to your initial contributions.
- Reinvesting Returns: With compounding, your returns are reinvested, so you earn returns not only on your original contributions but also on the returns that have already been generated. This creates a snowball effect, where your savings can grow exponentially faster over time.
Why starting early matters
Compounding becomes more and more powerful the longer you're invested. So, the earlier you start contributing to your KiwiSaver, the more time your money has to compound.
Here’s a simple example to illustrate this. Jane and James both have an annual salary of $50,000. Jane starts contributing 3% of her salary at age 20 to her KiwiSaver account whereas James starts contributing the same amount at age 30.
Figure 1 highlights that by the time Jane and James reach 65 years of age Jane has significantly more in her KiwiSaver account than James. This is because Jane's money had an extra ten years to benefit from compounding.
Figure 1. Jane and James' expected KiwiSaver balances at age 65, after different starting ages
How you can maximise compounding returns with KiwiSaver
- Start now: The best time to start investing is today. The earlier you begin, the more time your money has to grow.
- Contribute regularly: Make regular contributions to your KiwiSaver account. Even small amounts add up over time.
- Take advantage of employer and government contributions: Many employers match your KiwiSaver contributions up to a certain percentage. If eligible, the Government will also top up your KiwiSaver account with a yearly contribution up to a maximum of $521.43. Make sure you’re taking full advantage of this free money.
- Review your fund type: Choose a fund type that aligns with your personal risk tolerance and what you're going to use your KiwiSaver for - this will either be a deposit on your first home, or retirement. Having a clear vision of your plans, including the timeframe, will clarify what fund you need to be in. Higher-risk funds can offer higher returns, but they also come with more ups and downs.
- Stay the course: KiwiSaver was designed to be a long-term game. Market volatility is a normal part of investing but it can be a worrying time watching your KiwiSaver balance drop during a market downturn. We've seen many people lock in losses by switching to a more conservative fund during market downturns only to miss the gains made when the market eventually recovered. Avoid making any knee-jerk reactions as frequent changes to your investment strategy, especially during downturns, can disrupt compounding and reduce long-term gains. That's where Aurora's KiwiSaver advisers come in. They can help you stay on course and ensure you're in the right fund type for your situation.
Compounding returns are a powerful way to help your KiwiSaver account grow significantly over time. Remember, the key to success isn’t just how much you save, but how long you let your savings grow.
Harness the power of compounding returns with KiwiSaver and take control of your financial future.
DISCLAIMER
This information is provided in a general nature only and should not be construed as or relied on as financial advice. This is not a recommendation to invest in a particular financial product or class of financial products. You should seek financial advice specific to your circumstances from a Financial Adviser before making any investment decisions.
Past performance is not a reliable indicator of future performance. The value of your investment may go up and down.