Compound Interest

What do an avalanche and compound interest have in common? The answer? They both use the power of momentum to grow.

Compound interest is paid on your principle plus on the interest you have already earned. Once interest is added to your account, it starts earning interest itself.

For example, let’s say you invest $10,000 with a compounded interest rate of 6% per year:

  • At the end of the first year, you will have earned $600 in interest
  • At the end of the following year, the $10,600 in your account will earn $636 in interest, bringing the value of your investment to a total of $11, 236
  •  At the end of the third year, that $11,236 will earn $674.16 in interest

As the example demonstrates, even though your rate of interest remains the same at 6%, the amount you receive in interest increases each year ($600 the first year; $636 the second year; and $674.16 the third year). You receive more money each year, and you don’t have to lift a finger. How great is that?!

But wait, there’s more!

How frequently interest is compounded can impact how much interest you earn overall. An account earning a rate of 6% (like in the previous example) compounded quarterly will pay a little more than an account earning a rate of 6% compounded annually. And, the longer you have the account, the more it will end up paying you in interest.

Financial writer Carol Wiley suggests that starting early is the key to taking full advantage of compound interest. In her article “The Advantages of Compound Interest”, she says, “The power of compound interest is the reason that financial planning and retirement experts recommend starting a retirement plan early. A 20-year-old who places $5,000 in a one-time investment that earns an average 8-percent annual return would have $160,000 at age 65, while a 39-year-old who makes a one-time $5,000 investment at that rate of return would have only $40,000 at age 65.”

So, in conclusion, in order to make the most of every dollar you save, be sure to start your savings plan early. Also, look for an account that compounds interest frequently. Follow these two simple tips to harness the momentum and power of compound interest. Doing so will maximize your savings potential. And who doesn’t want that?

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