Compound interest is a rather simple concept in theory. It refers to reinvesting the interest earned on a positive balance in a savings or investment account to earn more interest.

Picture a snowball down a snow-covered hill. It goes faster as it gains momentum and becomes bigger the further it rolls.

So, with this picture in mind, compound interest can help you save money faster. Therefore, the earlier you invest or add money to a savings account and the longer you leave it to compound, the greater the benefit.

How to Calculate Compound Interest

Compound interest is still being hailed as the best strategy to increase wealth. If you want to calculate it on the initial investment of money in an account, it works as follows:

Calculate the initial investment by one. Add the annual interest rate and raise it to the number of compound periods minus one. Then, subtract the initial principal amount from the total value.

For instance, if a $100,000 deposit grows at 5% simple annual interest over 10 years, it would earn $50,000 in interest.

However, if a $100,000 deposit had a compound interest growth of 5% monthly, the interest would be around $64,700. You can use several online compound interest calculators to calculate total figures based on your specific deposit.

This is the foundation of compounding. Your money generates returns on returns.

Factors That Affect Compound Interest Growth

The size of your initial investment amount matters. The larger the sum, the greater the base from which compounding can work. The same goes for the interest rate. A higher interest rate means faster growth.

Also, if you invest earlier, your money has more time to grow so that you will get a larger final sum. If the interest is compounded more frequently (monthly), your money will also grow faster.

Making Compound Interest Work for You

You cannot control the interest rate, but you can improve your wealth creation by focusing on the other factors mentioned above. This means investing early, even if you start with a smaller sum.

You can reinvest your interest earnings from several accounts and investments. These include bonds, stocks, real estate trusts, and exchange-traded funds. If you want to grow your money over a shorter term, consider reinvested earnings from high-yield accounts, certificates of deposit, and money market investment accounts.

Choosing the Best Investments for Compounding

Generally speaking, savings accounts are your safest option for compounding interest. However, these come with low interest rates. Bonds are also considered a less risky option compared to stocks. Bonds can offer fixed-income payments, plus the potential for capital appreciation.

Compound Interest Continues to Build Wealth Over Time

Compound interest is one of the best ways to secure and grow wealth over time. At the same time, you must remember that financial markets are never static. This means past performance cannot be relied upon to ensure future results. However, you can build a secure financial future by following the basics: investing early and consistently and choosing the most suitable investment profiles for your needs.

Sources

https://www.forbes.com/advisor/investing/compound-interest/

https://www.investopedia.com/terms/c/compoundinterest.asp

https://www.experian.com/blogs/ask-experian/best-compound-interest-investments/