Savings and Compound Interest
(Part of me wanted to call this post Money, Money, Money to further allude to Rohan’s love of all things ABBA. But no… John, show some self-restraint!)
Recently I posted about iPhone hysteria. In that post I included a link to a comic from The Joy Of Tech. It was a tale of delayed gratification versus instant gratification, it championed the joy of compound interest. Now, admittedly, in my haste I may have suggested by not buying an iPhone you might become a millionaire. When what I meant was that there might be financial benefits to foregoing the technology.
Rob writes in the comments of iPhone, You Phone:
that comic actually annoys me a little… because its hardly accurate, can be said about practically anything, AND doesn’t mention the fact that OMG DO YOU KNOW HOW HARD IT IS TO GET A COUMP[O]UND INTEREST BANK ACOUNT?! they are very VERY rare and you pretty much need some sort of connection to end up with one.
There is great insight and merit in most of what Rob says. I crunched the numbers myself (with the aid of an online calculator) and it would require a very special set of numbers to actually reach the million dollar mark. It is true, also, that similar money could be funneled from anywhere – it need not be an iPhone that you are foregoing in order to meet the savings targets. The point remains, though, that the iPhone has substantial ongoing costs. (I’m using the information provided in the comic as assumptions for calculations. Tailor your own calculations with local information relating to the cost of the iPhone itself, connection fees and ongoing charges.) In addition to the $299 and $36 activation fee (represented as the initial amount of $335), there is also a monthly fee of $130.
Admittedly we are working with a lot of assumptions here. In the comic they speak of “the time you retire” as the term of the investment, but how long is that exactly? For the benefit of this exercise I am assuming that period is 30 years. Similarly, the interest rate is set somewhat arbitrarily at 10 per cent. At the time of writing (in Australia) it is probably more reasonable to assume something between 6-7%, though many online savings accounts will have ‘introductory rates’ of 8 per cent or more. (But more on that later.) Again, we can’t predict interest rate changes for the next thirty years, but this is a useful assumption for the purpose of this exercise.
Similarly, it remains uncertain whether the person would continue to use the iPhone for the entire 30 years. New models may replace existing models, and thus adding to the overall cost of the iPhone experience. Also, plans may change – again it is difficult to know what time will bring; will plans become cheaper or more expensive? Who knows…
So with those academic assumptions, I was able to generate the graph you see below.
Even with these assumptions the final figure isn’t a million dollars. But it is difficult to deny it is still impressive. An extra $47,135 is nothing to sneeze at surely? Of course there are opportunities for greater returns, but the nice thing about this approach is that it is very conservative. There is always a trade off between risk and rate of return, and the champions of compound interest will tell you it’s safe – and slow.
Finally I have to challenge one of Rob’s suggestions; specifically that you need a ‘special’ account for compounding interest. All you need to do is put money into a savings account and leave it there. The compounding takes place when you are earning interest on both the initial investment and the interest previously earned. All you need to do is not withdraw the interest already earned.
What I think Rob does allude to though is that most banking products people are familiar with offer little or negligible interest. A few years ago I was disillusioned, and slightly amused, to discover over the financial year I had earned a whooping five cents in interest! Your “transaction” accounts are never going to offer any great return on the money you leave in there. You’ll require a special savings account.
Most Financial Institutes (at least in Australia) offer Online Savings Accounts. These are typically linked are to an existing account, and can only be accessed by telephone or internet banking. A few examples are listed below.
- dragondirect (St. George)
- ING Direct
- HSBC Savings
- Rabo Plus
Obviously there are many more products available, and you are invited to do your own research. This post is of a general educational nature, and you should consult your own financial advisors or professionals before making any decisions.
I love my term deposit. ^^
The main fallacy with this type of reasoning is that money does not retain its value. You won’t, to use a topical example, be able to fill your car with petrol nearly as many times with $300,000 in thirty years time as you will now. Of course, the idea of investment is that the fund grows at a faster rate than the depreciation of the currency, so you do make money, but not as much as it seems when you look at the figures.
:P sorry its taken me so long to read.
I would NEVER keep it for 30 years and I wouldn’t take the 130 a month plan, thats precicely why im waiting. =P
and i meant monthly compounding, (which is what it states in the comic) every saving account is compounding.
still… interesting… BUT NOT AS INTERESTING AS AN IPHONE OMG I STILL WANT ONE!!
=P
Thanks for the post. Stumbled upon it rather late. There are many compound interest calculators available on the Web but the principal of compound interest is really very simple: it’s just money you make on your savings
Monicas last blog post..Debt by the meter