Return matters, but so does time: how compound interest makes your savings grow faster and faster, with worked examples.
When people talk about savings, they usually focus on the return of an investment. Yet another factor plays just as important a role in building wealth: time.
By letting the gains of an investment be reinvested over the years, you benefit from a particularly powerful mechanism: compound interest.
How does compound interest work?
The principle is simple: the interest earned by your savings is added to the initial capital and in turn generates new interest.
Let’s take an example. You invest €100,000 with an annual return of 5%.
- In the first year, your investment earns €5,000. Your capital therefore reaches €105,000.
- In the second year, the 5% is no longer calculated on €100,000 but on €105,000. You earn €5,250, bringing your capital to €110,250.
- And so on, year after year.
This is the mechanism that makes your savings grow faster and faster over time.
€100,000 invested: how does it grow over 20 years?
To measure the effect of compound interest, let’s compare three annual return assumptions: 2%, 3% and 5%.
| Term | 2% return | 3% return | 5% return |
|---|---|---|---|
| 5 years | €110,408 | €115,927 | €127,628 |
| 10 years | €121,899 | €134,392 | €162,889 |
| 15 years | €134,587 | €155,797 | €207,893 |
| 20 years | €148,595 | €180,611 | €265,330 |
With an annual return of 5%, your initial capital of €100,000 grows to more than €265,000 after 20 years, without any additional payment.
Another striking finding: a difference of just 2 points in return, between 3% and 5%, amounts to almost €85,000 after 20 years.
Return matters, but it is its combination with the length of the investment that makes all the difference.
What if you save €200 every month?
You don’t need a large amount of capital to benefit from compound interest. Setting aside a sum every month can also help you gradually build up wealth.
Take the example of someone who saves €200 a month, with no initial capital.
| Term | Amount paid in | At 2% | At 3% | At 5% |
|---|---|---|---|---|
| 5 years | €12,000 | €12,604 | €12,916 | €13,563 |
| 10 years | €24,000 | €26,519 | €27,890 | €30,873 |
| 15 years | €36,000 | €41,883 | €45,248 | €52,965 |
| 20 years | €48,000 | €58,846 | €65,371 | €81,161 |
| 25 years | €60,000 | €77,575 | €88,699 | €117,147 |
After 25 years, this person will have saved €60,000. With an annual return of 5%, their capital could reach around €117,000, almost double the amounts actually paid in.
This clearly shows the value of setting up regular savings, even modest ones, and keeping them long enough.
Why is starting early so important?
In the first few years, compound interest produces relatively modest results. It is over time that its effect becomes significant.
Going back to our example of €200 saved every month at 5%: after 10 years, the gains amount to around €7,000. After 25 years, they exceed €57,000.
In other words, the longer the investment, the more the accumulated gains can contribute to the growth of your capital. That is why starting to save early, even with small amounts, can be more effective than waiting several years to invest larger sums.
Return isn’t everything
To make the most of compound interest, you still need to choose suitable investments.
A higher return generally comes with greater risk. Fees, taxation and the availability of your savings must also be taken into account.
The simulations shown are based on constant annual returns, with gains reinvested, before fees and tax. They are given for illustration only and are not a guarantee of performance.
The aim is therefore not to systematically look for the highest return, but to build an investment strategy that is consistent with your situation, your plans and your investment horizon.
And your savings: could they be put to better use?
Do you already have savings, or would you like to start building up capital? At Tolteka, we review your current investments and look at the investment solutions most likely to meet your goals.
We offer a first meeting, free and with no commitment, to discuss it.
