By Soh Chin Heng
Mr Soh Chin Heng, or CH as he is commonly called by friends, is the Deputy Chief Executive (Services) of the Central Provident Fund Board Singapore. He oversees the Board's customer service and schemes administration, and is the Board's engagement champion. He is a non-practising certified financial planner, and gives regular talks on CPF and financial security.
What do Albert Einstein and Warren Buffet have in common?
For one, they are obviously very intelligent. Geniuses in their own right. And they share a common belief – in the power of compound interest.
Einstein said, "Compound interest is the 8th wonder of the world… he who understands (it), earns it… he who doesn't, pays it…"
Buffet demonstrates it by his wealth. The picture below shows Buffet's net worth over time. The eye-catching thing is the exponential shape of the growth of his wealth, and it can be explained by the power of compounding.
Simply put, compound interest is earning interest on interest. If you start with $100 earning the current CPF Special Account's interest base rate of 4% p.a., you earn $4 interest over a year and your balance becomes $104 after one year. In the second year, your interest is a little more than $4 because the $4 interest in the first year attracts interest as well. The difference may seem insignificant; however, over a long time, it adds up and can have a tremendous effect on your wealth accumulation.
A simple rule of thumb to visualise the power of compound interest is the Rule of 72. Divide 72 by the interest rate, and the answer is the number of years it takes to double your money. If you start with $100,000 and leave it in a bank's savings account at the current interest rate of 0.05% p.a, you will have about $102,000 after 36 years. The same $100,000, earning 4% p.a. and 8% p.a., grows to $400,000 and $1,600,000 respectively. That's a lot of difference!
Obviously, the question is, where can one invest to earn 4% p.a. or better still, 8% p.a.? And what risks does one have to take to try and earn such returns? In the next article, I will share how you can milk the CPF to increase your wealth.
This article is part of a series by Mr Soh, who will be sharing tips on how you can chart your way towards financial security. Read more:
The Most Important Financial Question
Your Financial Security Compass
Your Lifetime Financial Partner