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Compound interest is simply reinvesting the interest you've earned so that you earn interest on your interest. But until you look at practical examples you don't realise how it can make your savings snowball.

Case study

Four sisters, all the same age and their investments all earn 8% pa (4% growth and 4% income).

Anna: At the age of 21 Anna invests $5,000 and then adds $1,000 a year — until she turns 30. She adds nothing more. A total investment of $14,000. Anna does not reinvest her 4% pa investment income.

Belinda: Does exactly the same as Anna but takes advantage of compounding and reinvests her 4% pa investment income.

Cassie: Delays investing her $5,000 until the age of 31, but saves a lot harder, contributing $1,000 a year until she's 65 – investing a total of $39,000 (compared to Anna and Belinda's $14,000). Cassie doesn't reinvest her 4% pa investment income.

Diane: Does exactly the same as Cassie (starting at 31 and investing a total of $39,000) but takes advantage of compounding and reinvests her investment income.

At the age of 65, you can see the outcome for the four sisters on the table. The two sisters who take advantage of compounding, Belinda and Diane are streets ahead. But Belinda is also ahead of Diane – even though she invested only $14,000 compared to Diane's $39,000, because Belinda harnessed the power of both compounding and time.