This is the third in a series of six articles, published between October 1 and 6, in support of the Bermuda Stock Exchange World Investor Week Quiz Challenge. Each article has a question embedded. Find the question and send your answer to wiwqc@bsx.com. Those with six correct answers will be entered into a draw to win a grand prize of a $2,500 Bermuda securities portfolio.

The magic of compound interest is perfectly illustrated by a parable of a king who lost his kingdom, and it all started with a promise of a single grain of rice.

The king, excited about the game of chess, offered one wish to the inventor of the game. The sage inventor asked the king to place one grain on rice on the first square of the chessboard, two on the second, four on the third and so on — and to keep doubling the grains on each of the subsequent 64 squares of the chess board. Surprised that the inventor did not ask for money or jewels, the king agreed.

The first few squares cost the king one grain, then two, then four. By the end of the first row, he was up to 128 grains of rice.

But in the second row, the grains of rice grew exponentially. By the 21st square, he owed more than a million grains; by the 41st row, he was in for more than a trillion grains. When the 64th square was reached, the inventor was owed more than 18-trillion grains of rice.

And so, as the parable goes, the king bankrupted his kingdom by granting one simple request.

What the inventor did by asking for double the value in each square on the chess board was putting compounding into effect.

Compound interest is the central pillar of investing. It is why investing works so well over the long term.

If you saved $10,000 at a return of 6 per cent and withdrew your interest at the end of every year, by the end of ten years you would still have $10,000 and would have drawn the interest portion of $600 each year — or, in total, $6,000 over the ten-year period.

On the other hand, if you added the $600 interest you earned to your capital of $10,000, you would start the second year with $10,600 and earn interest on both your original $10,000 and on the interest earned in the previous year.

By reinvesting your returns, after ten years your investment will be worth $17,908 and, after 20 years, you would have $32,071 — all of this from your single investment sum of $10,000.

In short, you are earning more interest each year because the amount invested each year is increasing, without you making any additional investments.

The longer your money is invested, the higher the impact of compound interest — so time is key.

Enter the Rule of 72. This is a shortcut to estimate the number of years required to double your money at a given annual rate of return. The calculation is to divide 72 by the percentage rate of return.

For instance, if you invested $100 today and earned 6 per cent a year on your money, it would take about 12 years for the $100 to grow to $200 (72/6 = 12).

As time cannot be manufactured, the only way to maximise returns is to start saving as young as possible — for practical reasons, it means starting when you start working and earning an income.

Consider the example of two university graduates, Serena and Mark, who are both starting their careers. Give the address of the Bermuda Stock Exchange.

From age 25, Serena saves $1,000 a month in a fund. Over time, the fund in which she has invested generates a return of 8 per cent per year on average. After a decade, by age 35, her investment will be worth $181,283. The amount she’s saved every month totals $120,000 but the rest of that growth — $61,283 — is all due to compound interest. At this point, Serena decides to stop her monthly contributions.

Leaving compounding to work its magic means her investment will have grown to $1.24 million by age 60. Remember, this is with no additional contributions.

Mark is 35 when he starts saving for retirement. He invests $1,000 a month in a stocks and is also lucky enough to receive an average return of 8 per cent.

By age 60, Mark will have saved $914,839, and he is happy. His contributions over this time will amount to $300,000, with interest totalling $614,839. Compounding did the trick for him too.

But because of the benefit of time — a head start of ten years — Serena has saved $326,000 more, despite contributing only 40 per cent of what Mark contributed ($120,000 versus $300,000). Those ten years make a remarkable difference and illustrate the benefit of saving — and putting compound interest to work — as early as possible.

Retirement may seem a long way off if you have just started working, so why worry about how much money you need when you retire?

If you are in your 20s and 30s, you have time to build up a retirement nest egg — and you have a powerful friend called compound interest, which is a smart name for earning interest on interest.

Even if you are already in your 30s, 40s or 50s, it is never too late to start saving for your retirement, but the younger you are when you start, the more you stand to benefit and the less money you need to put away each month to reach your target. It’s all about allowing time for your money to grow.

This article is based on a piece written by the Money editorial team at Tiso Blackstar

For full details of the WIW Quiz Challenge, see details attached to the online version of this story at www.royalgazette.com under the heading, Related Media