The power of compound interest: How your money makes money

You’ve probably heard the phrase compound interest before, but what does it actually mean? And why do financial experts talk about it like it’s magic?

In simple terms, compound interest is when your money earns interest… and then that interest also earns interest. Over time, this creates a snowball effect that can make a huge difference to your long-term savings or investment balance.

Here’s how it works and why starting sooner can really pay off.

What is compound interest?

Let’s say you invest $1,000, and it earns 5% interest per year. At the end of one year, you’ve made $50 in interest so your balance is $1,050.

In the second year, you earn interest not just on the original $1,000, but also on the $50 you gained in year one. That means your interest for the second year is slightly more—$52.50.

It might not seem like much at first, but over 10, 20, or 30 years, that extra bit of interest-on-interest really adds up. That’s the power of compounding returns.

Why time is your biggest advantage

When it comes to compound interest, time is everything. The earlier you start saving or investing, the more time your money has to grow, potentially reducing the amount you need to contribute compared to someone who starts later with the same goal.

Even small, regular contributions can grow into something substantial if you leave them alone to do their thing. That’s why starting early, even with modest amounts, can work in your favour far more than trying to “catch up” later with larger sums.

KiwiSaver and compounding

If you’re contributing to KiwiSaver, you’re already harnessing the power of compounding returns, especially if your employer and the government are also adding to your account.

Your contributions, combined with investment returns, are invested into your fund. Over time, those returns generate their own returns, which helps your balance grow faster the longer you leave it untouched.

Switching to a lower-risk fund or pausing contributions during market dips can lock in losses and may reduce the long-term benefits of compounding returns.

It’s not just interest, it applies to investments too

While we often talk about compound interest, the same concept applies to other investment returns. Whether you're in KiwiSaver, a managed fund, or other types of investments, reinvesting your returns rather than withdrawing them is how you can take full advantage of compounding.

That’s why many people choose to reinvest dividends or earnings rather than spending them, especially in the earlier stages of building wealth.

Want to make compounding work harder for you?

If you’re keen to grow your savings or investments faster, there are a few simple ways to boost the compounding effect:

• Start early – even small amounts make a difference over time.
• Contribute regularly – set and forget can be powerful.
• Stay invested – avoid withdrawing unless absolutely necessary.
• Review your strategy – make sure your fund or investment matches your goals.

Want to make the most of compound interest or check if your current strategy is on track? Get in touch, we’re here to help you make well-informed decisions so that you can grow your savings with confidence.

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The information contained in this publication is intended for general guidance and information only. It has not been personally prepared for you. Therefore, you should not act on this information if you have not considered the appropriateness of this information to your personal objectives, financial situation and needs. You should consult with us before making any investment decision. Historical market performance may not be indicative of future market performance.

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