If you’ve ever considered saving money, then the idea of compounding interest could be very appealing. After all, the more time you put into saving the better. For example, if you set aside $10 every day for 20 years, that would be a total of $200.
If you had invested that same amount at 8% interest for those same 20 years, then you would have earned an extra $2,000. Meaning – just by investing your money instead of spending it.
This article will explain exactly what compounding interest is and how it can help you grow your savings faster than normal.
What is Compounding Interest?
There are many types of interest, but the most common is simple interest, which is simply the amount of money you’re earning on your money as you keep it in an account. For example, if you have $5,000 in a savings account earning 5% interest, you’d end up with $5,000 (or $625) at the end of the year.
Compounding interest, on the other hand, is when you earn interest on your interest. It’s a little like earning money by making money. The way this works is you take your original amount (the $5,000 in our example) and then you add that amount to your account at regular intervals (every month in our example).
If you then keep the account open for another month and add that $5,000 to your account again, you’d be earning $625 on your $625 the second time around!
How Does Compounding Interest Work?
If you want an example of how compounding interest works, let’s say you deposit $5,000 into a savings account that earns 5% interest. In the first year, you would make $500, and in the second year, you would make $500 again, and so on.
After five years, you would have $5,625, and after 10 years, you would have $10,625. This is because the amount you had originally invested continues to earn interest for you. That means that $5,625 at 10 years would be worth $63,750.
When you add each amount together, you get the total, but that total also includes the amount you’ve already made with interest. You would have $5,625 plus $625 plus $625 plus $625, totalling $10,125.
If you kept this amount in the savings accounts for another 10 years, you would have $63,750 plus the original $5,000, totalling $83,750.
Benefits of Compounding Interest: Key to Wealth Building
Wealth is the sum of your earnings over time. Compounding interest is the key to wealth building because it makes your earnings count even more. When you earn simple interest on your funds, it’s like leaving them inside your mattress. You can’t take them out and spend them.
With compound interest, though, you can invest your money and make more money. The more you invest, the more interest you make, and the more you make, the more you invest, and it just goes on like this forever. This means that your wealth continues to grow exponentially.
Things to Consider When Compounding Interest
Time – It takes time for compound interest to make a difference. You have to keep your money in the bank for at least one year for it to start making a profit. If you don’t keep your money in the bank for at least one year, it won’t start earning interest until the next year.
Risk – Sudden changes in the market can affect the amount you get back. For example, when the 2008 market crash happened, a lot of investors lost a lot of money. If you invest in the stock market, you can expect some of your earnings to go down with the rest.
How to calculate compound growth rate for starting money
Now that you know the basics of how compounding interest works, let’s say you want to know how much your money will grow over a certain period. To do this, you need to calculate the compound growth rate, which is a number between 1 and 9 that shows you how much your money will grow over a certain period.
To do this, take your original amount and add 10 times that amount. So in our above example, if you had $5,000 and wanted to know how much it would be worth after 10 years, you would add $5,000 to $105,000, or $10 times $5,000. You can find the compound growth rate for various amounts on this website.
Conclusion
If you’re looking for ways to increase your savings, then compounding interest is a great way to do it. It takes a long time for your savings to earn interest, but once they do, they start rolling in.
This is why it’s important to keep your money safe in a high-interest account. If you’re looking for ways to increase your savings, then compounding interest is a great way to do it. It takes a long time for your savings to earn interest, but once they do, they start rolling in. This is why it’s important to keep your money safe in a high-interest account.