How compound interest works

Compound interest is one of the most powerful forces in finance.

Albert Einstein is said to have famously described compound interest as the eighth wonder of the world.

The Australian Securities and Investment’s Commission’s (ASIC) MoneySmart website¹ says the sooner you start to save, the more you'll earn with compound interest. 

Compound interest in practice

ASIC’s MoneySmart compound interest calculator² illustrates where compound interest might take you and the impact of starting early for long-term investing.

The calculator shows that through investing early and utilising compound interest, a 20-year-old who starts putting aside $110 a fortnight at a 5% per annum net investment return may save close to half a million dollars by the time they’re 65 years old. 

With $128,700 in regular deposits over 45 years, they may earn $354,268 in total interest for total savings of $482,968. 

What compound interest means for savings

Superannuation is perfectly placed to benefit from compound interest because the compounding effect happens automatically over decades.

According to the MoneySmart superannuation calculator³ and showing all amounts below in today’s dollars adjusted for inflation:

	A 25-year-old who earns $50,000 and wants to retire at 60 could have a super lump sum of $252,000 if they invest in a typical default option for those funds over 35 years.
$10,000	If that same person started with $10,000 in super at age 25 their final balance could be – $273,000 – so that $10,000 at the start creates an extra $21,000 of wealth through compound interest.
$25/week	And if they also decide to deposit $50 a fortnight extra into their super through salary sacrifice, their final super balance could be $330,000. At $100 extra per fortnight, their final super balance could be $388,000 thanks in part to the benefit of compounding returns.3

1. Australian Securities and Investment Commission, MoneySmart, Compound interest, accessed 16 February 2024, at moneysmart.gov.au/managing-your-money/saving/compound-interest
2. ASIC, MoneySmart, Compound Interest Calculator, accessed 16 February 2024, at moneysmart.gov.au/tools-and-resources/calculators-and-apps/compound-interest-calculator. Amounts are shown in future dollars, which means they have not been adjusted for inflation.
3. ASIC MoneySmart, Superannuation calculator, accessed 16 February 2024, at moneysmart.gov.au/how-super-works/superannuation-calculator. This calculator works for accumulation funds only. It will not work for defined benefit funds. It assumes your account balance will receive all income and outgoings mid-year, apart from Government co-contributions (if any) which are assumed to be received at the end of the year. It assumes that your employer contributes an amount equal to 11% of your ordinary time earnings. This rate is assumed to increase by 0.5% per annum until it reaches and stays at 12% from 1 July 2025 onwards. The default settings in this calculator for fees, investments, insurance and inflation were used when calculating the superannuation balance amounts, including an assumed investment return (before investment fees and tax) of 7.5% p.a., investment fees of 0.85% p.a. and an effective tax rate on investment earnings of 7.0%.  Actual returns will vary significantly from year to year and could be negative in some years, particularly for investment mixes where more is invested in shares and property. This calculator does not allow for such variations. Amounts have been rounded and are shown in today’s dollars, which means they are adjusted for inflation. Projected results are shown at 1 July after the person’s 60th birthday, assuming the person is exactly 25 years old on the calculation date. So these results may vary depending on when you access this calculator during the calendar year.