Benjamin Franklin is famously quoted as describing compound interest as “the eighth wonder of the world.” It is one of the fundamental principles of investing and should be a finance tool that everyone utilizes for maximum effect!
Compounding comes in several varieties, but all break down to essentially the same thing: your interest builds interest. Compound interest means that instead of interest building on your principle alone, you earn money on that and on all the money you’ve earned on the money. Simple interest pays only on the principle balance, so your money aggregates much more slowly. This can unquestionably get a little confusing, but this is one of the most powerful tools out there for anyone to use to make money.
Compound interest generally defines a period of compounding. This is the rate at which your interest upon interest is recalculated. Periods can be anything from daily to annual, so be sure to find out! The period of compounding greatly impacts the amount you earn over the life of your investment – the shorter the period, the more you make! Let’s take a look:
$1,000 of principal invested at 5% compounded annually will be worth $1,050 at the end of one year. The same amount compounded quarterly is worth $1,050.95, monthly becomes $1,051.16, and daily increases to $1,051.27. The chart below makes this a bit easier to visualize.
One Year at 5% Interest Comparison
Now, I realize that $1.27 is not a huge difference, but consider that that is on just $1,000 over the course of just one year. There is a snowball effect on compound interest – over time, these differences come to be dramatic. Let’s not touch our $1,000 for a few years and see what happens! The differences are likely to astound you. Take a look at how to use your spare change to bring this about!
5% Interest Comparison Over Time
Now, compound interest clearly isn’t going to make anyone rich overnight. It is a long, slow process, but one which keeps on paying over time. Take advantage of itwith anything you don’t have in some other vehicle paying faster rewards!
Tags: banking, interest, investing, money, Retirement, savings
