What is compound interest
For savers, the definition of compound interest is important. Compound interest is the interest earned on the principal plus the interest that keeps accumulating. With compound interest, your savings will grow faster over time.
An account that pays compound interest, such as a standard savings account, adds income to the original principal at the end of each interest period, usually daily or monthly. Your balance increases as interest is calculated and added to your account. With the compound interest formula, your account will earn more interest in the next compounding period.
For example, $10,000 in a savings account with an annual interest rate of 4% will compound interest daily, earning $408 in year 1, $425 in year 2, and an additional $442 in year 3. You can. After 10 years of compounding, you will have earned a total profit of $4,918.
But keep in mind this is just an example. For long-term savings, there are better places to keep your money than savings accounts like Roth and traditional IRAs and CDs.
Double your return on investment
Investing in the stock market yields returns based on changes in the value of your investment rather than fixed interest rates. When the value of your investment rises, you earn income.
If you store money and invest the profits you make in the market, the profits will grow over time, just like interest.
If you invest $10,000 in a mutual fund and the fund returns 6% in one year, you’ve earned $600 and your investment is worth $10,600. With an average return of 6% next year, your investment would be worth $11,236.
This money can actually increase over the years. If you keep this money in your retirement account for 30 years and the average rate of return is say 6%, $10,000 will grow to over $57,000.
When it comes to investments, there are plenty of options available, depending on your life stage, goals, and the sum you’re able to invest. Regardless of your situation, if you’re interested in boosting your savings over the long term, a compound interest savings account might be precisely what you’re looking for.
Understanding how compound interest works will help you to make smarter investment decisions. In this article, you’ll learn what compound interest is, how it can increase your savings over time, and how to find out if it’s the right option for you. Ready? Let’s go.
What is compound interest?
Let’s get really granular: The word “compound” refers to something made of two or more elements, while “interest” is money paid for money lent or deposited. Given this, compound interest is effectively interest that’s calculated on an account’s principal balance—which, for a savings account, is the original balance that you deposit. In the case of compound interest, you’re generating “interest upon interest.” It adds interest based on the initial interest rate, and this includes interest accumulated from previous periods.
Compound interest can combine interests on any given schedule: daily, monthly, or even annually. So, with a savings account that earns compound interest, you’ll earn interest on the initial principal and the accumulated interest over time. Let’s look at some examples to understand more.
