Select Page

Compound interest : the snowball effect

Why your pension holds the power to a better future

A famous man once said that something was “the most powerful force in the universe.”

Can you name that something and the man without reaching for Google to find the answer? Here’s a clue. This man = mc²

Top marks if you said, Albert Einstein!

But, what on earth was he talking about? Well, the force he was describing wasn’t the Jedi kind, much to our disappointment. He was talking about a force that is definitely real and should benefit you far more, especially when you reach retirement. Sorry Star Wars fans!

It’s called compound interest. And, one of the best ways of getting hold of that power is your pension.

What is compound interest?

As with most things about pensions, compound interest doesn’t sound particularly interesting. Yet, understanding what it is and how it can benefit you, could mean being one step ahead of your peers.

The basic principle of compound interest is this. When you save money, it will generally earn interest. That interest will then earn interest. And there is the potential power.

Now, you get interest for most savings vehicles. The thing is, the rate of return you get is often low, especially when it comes to standard savings accounts and cash ISAs. And the low returns can really blunt the potential power of compound interest.

To boost that power back to maximum, you need a savings vehicle with a potentially much better rate of return. This is where your pension comes in, (as long as it’s a good one).

Pension compound interest

For example, let’s say from the age of 25 you chose to put £20 in a jar each month rather than a pension. By the time you reach 65, you’ll have £9,600.

Put it in a savings account with an interest rate of 0.5% per year and you’ve got over £10,625 by 65.

Now, if you chose to save that £20 into a pension growing, on average at 6% per year, by 65 you’ll have £38,000. That’s the power in action.

Yet, it doesn’t stop there. The tax relief you get on a pension is essentially free money! This gives a massive turbo boost to the already conquering power of compound interest.

Tax treatment depends on your individual circumstances and may be subject to change in the future.

Another way of looking at this is the snowball effect.

You push a small snowball down a hill and as it travels more snow gets packed on with each roll. When it reaches the bottom of the hill, you’ll see that the snowball has grown into a snow boulder.

The snowball effect shows that small actions carried out over time, can lead to big results and this is exactly what compound interest could do for your pension.

The benefits of having a pension

Please share if you found this useful