The Importance of Compound Interest And Reinvestment


- Advertisement -

When I was much much younger, I watched an episode of Futurama that really stuck with me. It was episode six, ‘A Fishful of Dollars’, when Fry rediscovers his old bank account. In the year 2000, before the spending 1000 years frozen in a cryogenic tube, Fry had a bank account balance of 0.93 cents working as a Pizza Delivery boy in New York City. Then, he returns in the year 3000 and rediscovers his old bank account with a staggering balance of $4.3 billion, accumulated over 1000 years thanks to compound interest.

Lets do that math: 0.93 Cents, 1000 years, compounds to $4,283,508,449.71 (exact figure revealed in the episode), was actually invested for 2.25% interest.

Well, time machines haven’t been invented yet, but what this episode taught me is that, even with a modest interest great things are possible. It proves that given enough time on your side, even a meagre investment such as 0.93 cents, can grow into something.

Therefore, as savers, we are always looking for ways to grow our money exponentially and beat inflation at the same time. As such, I am not talking about just investing for compound interest, but also reinvesting investments. Reinvesting your returns is key to turning small investments into huge returns. It allows interest to also earn it’s keep by generating interest as well. The more we reinvest, the more money we accumulate over time.

The Power of Compound Interest

Compound interest is a real-world phenomenon famously highlighted by Albert Einstein, who famously said that “Compound interest is the 8th wonder of the world.  He who understands it, earns it; he who doesn’t, pays it.” Compound interest generates exponential growth – something that most of us do not truly understand. In finance, exponential growth is always lurking behind debt, inflation and compound.

Think about how a KES 1000 debt, quickly grows to KES 200 interest after a short-period of time. Also, think about how KES 100 was more than enough to buy several household items back the year 2000 – just 20 years later, you can only buy a bag of flour. This is how the compounding effects creep – higher and consistently – ratcheting up, costing us more.

In spite of its ugly side there is a beauty to it. The to key is to understand it and apply it by garnering enough momentum to break free from the aforementioned opposing powers (particularly inflation). To bear inflation, you’ll need to invest your savings into an investment that pays higher interest. Don’t just park your money in the bank to lose it safely.

Imagine if Fry had bought stocks with his money. We would be talking about an insane amount now.

Learn more: Is the Bank A Place to Save Money?

Time x Interest

The key to reinvesting for savers is to generate interest over interest by applying interest rate on initial capital multiple times as well as on returns that will be generated. The fundamental variable for this is time, as the more time you give your investment, the more money you accumulate

Here is a simple demonstration of the snowballing returns over time upon reinvestment of a coupon:

Let’s say we have a KES 100,000 of a bond, with a annual coupon rate of 10%. Our first coupon is 10% of KES 100,000, KES 100,000. If we reinvest our coupon, the next year we will have KES 11,000 in principal. Our second coupon payment will be 10% as well of KES 11,000, KES 1,100.

  • Total returns with simple interest: KES 100,000 X 10% X 10 Years = KES 100,000 interest plus KES 100,000 capital repaid = KES 200,000 returned.
  • Total return with compound interest: KES 100,000 X (1+10%)10 = KES 259,372 returned (KES 159,372 interest and KES 100,000 capital repaid).

With this example, it is evident that investors who reinvest their coupons reap the most benefits from bonds.

Growing Your investment with Compound Interest

Four things you need to do to grow your investment with compound interest:

  • Invest for longer periods. The more years invested (i.e. compounding periods) the more interest you will generate.
  • Invest for growth. Leave you investment alone – making any withdrawals will not compound effectively
  • Start early. To adequately enjoy growth without taking on too much excessive risk to meet your investment goals, start investing as early as possible.
  • Reinvest all returns. Reinvestment dividends, bonds, rental income and more to keep your money growing. Reinvesting allows us to maximize returns.

Learn more: How to Make 20% On Dividend Yields Every Year

Investments That Give Good Compound Interest

Many different types of investments offer impressive rates of compound interest. However, you need to consider how long you are willing to tie up your money for against what the returns will be.

You can invest in:

  • CDs (Certificate of Deposits)
  • Unit Trusts such as the money markets funds
  • REITs ( Real Estate Investment Trusts)
  • ETFs (Exchange Traded Funds)

All in all, weigh up the risk and rewards, and work out the duration of your investment.

Learn more: How to Save Smart With A Certificate of Deposit Ladder

The Rule of 72

If you want to estimate how long it will take you to double your money through compounding, consider using the rule of 72. You simply divide the number 72 by the yearly interest rate you earn from your investment.

Example – if you are investing your funds at 10% interest, it will take you 7.2 years (72÷10) to double your investment if left untouched.

A few things you need to note:

  • This rule only provides a quick estimates.
  • It tends to only works as long as the interest rate is less than 20%.
  • It doesn’t take into consideration the changes that may take place in the duration of your investment.

Learn more: How Time Can Turn KES 20,000 into KES 10M

The Importance of Reinvesting

A lot of people lack the patience needed to accumulate wealth slowly using compound interest. Though we don’t have 1000 years to spare, a time machine or cryogenics tube to wait things out, all is not lost. We can still take advantage of the power of exponential growth in our lifetime. Therefore, I want to stress the importance of compound interest, particularly in reinvesting your returns to a maximize capital.

The way things are now, as savers, we need to look for all alternatives that allow us to reach our investment objectives in the future. So, if you aren’t already taking advantage of compound interest with your investment, you aren’t maximizing. Maximize, and ensure that you are on track to meet your overall investment goals over the next 10 to 20 years.

Happy Building!

Image credits: Top by Gabby K via Pexels

- Advertisement -
Irene Makanga
Irene has an MBA in Finance and is an avid businesswoman, passionate about financial literacy.



Please enter your comment!
Please enter your name here

Share post:

- Advertisement -


- Advertisement -


- Advertisement -

More like this

10 Unpopular Money Opinions That Everyone Should Think About

We live in unusually tough times and a lot...

How to Save, Spend, and Think Rationally About Money

Financial concerns can cause stress, regardless of income level....

4 Empowering Tiers to Navigate Your Journey to Financial Independence

Financial freedom goes beyond mere independence from external constraints....

7 Essential Factors to Consider While Buying Property in Kenya as a Foreigner

Your Guide to Buying Property in Kenya as a...