One of the most exciting lessons to be learnt about finance and investing is the magical power that compound interest has on your savings.

It is a simple lesson, and one that is often overlooked. But it is the very reason why it is worth starting to save, today, with small regular savings.

Compounding, very simply, means that the value of your savings continues to grow as you earn increasing interest upon the increasing amount of money you have saved. It means that your money starts working for you to earn you more money, which will increase your choices and begin to set you up for financial security and independence.

If you decide at 16 years of age that you will start to save $20 each week and put this money into a cash savings account at 5% interest, then at the end of 5 years you will have saved $5,891.

At this point, at 21-years-old, you might decide to up this weekly saving amount to $50 each week. If that was the case then in a further five years you will have saved $22,248.

If at 21, you decide to increase this amount to $100 a week, then when you turn 26 you will have saved $36,978.

These calculations are made assuming a 5% interest rate, however interest rates continually rise and fall. In five years time interest rates on savings accounts might have returned to 8% — a rate that was available less than a year ago.

Using this example, assuming a 5% interest rate for 5 years saving $20 a week and an 8% interest rate for a further 5 years of $100 each week, then this 16-year-old would turn 26 with $40,390.

What a wonderful amount of money to have access to in your mid-20s! Imagine all the choices it would offer you to continue to invest for your financial future. Not to mention the good saving habits you would have grown up with and the valuable lesson you would have learnt that just a tiny amount of discipline and a small sacrifice with small regular savings, can lead to huge financial gains.

Don't you wish someone gave you this advice when you were 16 — are there any 16-year-olds you can share this information with to help set them up from an early age for their financial future? We explore the topic of compound interest and the benefits of a passive income stream in further detail in our book Flirting with Finance, www.flirtingwithfinance.com.au.

So why not open a savings account today? You can compare the interest rates on different savings accounts at the independent information provider: www.infochoice.com.au.

You might also like to play with the savings and investment calculator to work out how to reach your targets or how much you can save over time. Visit www.fido.asic.gov.au.

Next week we will discuss the difference between At Call Savings Accounts, Fixed Term Deposits and Managed Funds to explain some of the savings options available to you.

Have you developed a habit of saving and passed these good habits onto your children? Tell us your tips below...

Flirting with Finance is a book written by Anneli Knight and Virginia Grahamwww.flirtingwithfinance.com.au


Tags Money Finance savings anneli knight compound interest