Compound interest effect

December 26th, 2018. 06:09 pm

Compound interest refers to the way that the interest one earns from an investment gets multiplied in earning more and more interest. Taking a long view, the interest that you earn from your stocks (i.e., the dividends) is put back to investment, generating a compounding effect that will bring you even higher returns. Money, as it were, simply grows by itself.


Contributing to MPF is a way of getting ready for retirement, and as such, is a long-term investment.  The length of contribution has a major influence on the accrued benefits of your MPF.  Through the compounding effect, your monthly contribution will turn into a better income source after a long period of investment, thus better preparing you for retirement.


The key term of the compounding effect is time. When you begin your investment is more important than how much you put in the investment. It is therefore important that you invest early. The profit that you gain will grow even more as you put it back in the investment.


As shown in the diagram below, in the absence of any investment return, a monthly contribution of $1,500 will grow to become $360,000 in 20 years, and $ 720,000 in 40 years.  However, on the basis of a 2% return in a MPF, the same monthly contribution will grow to become $442,000 in 20 years and $1,102,000 in 40 years.  If the return is higher, say 3%, a monthly contribution of $1,500 will become $492,000 in 20 years and $1,389,000 in 40 years.



(Source: Mandatory Provident Fund Authority, 2016. A 15-year Investment Performance Review of the MPF System (1 December 2000 – 30 November 2015))



It can be readily seen that the earlier you participate in MPF and the longer your contributing period is, the more visible is the compounding effect and the higher is your return.