Compound Interest: Start now – your future self will love you for it
Compound Interest. Many of us have heard of this concept and it most often
comes up when thinking about the growth of savings or investments over the
long term.
Compound interest is what makes money grow. Compound interest is what happens
when the interest you earn on savings begins to earn interest on itself. As
interest grows, it begins accumulating more rapidly and builds at an
exponential pace.
So, how does compound interest work? It turns out it’s not that
complicated―and you can use it to your advantage to make the most of the money
you’ve got.
What Makes Compound Interest Powerful?
Compounding happens when interest is paid repeatedly. The first one or two
cycles are not especially impressive, but things start to pick up after you
add interest over and over again.
Take investing for retirement, for example. Compounding interest is the reason
why we benefit from starting as soon as possible: Your early investments
generate interest earnings, resulting in a higher investment for the next
interest period. This cycle continues so that the interest you’re earning is
continuously calculated based on a new, higher amount because it includes
interest already earned. Basically, your interest earns interest, which earns
more interest, and so on.
Making an investment in a compounding account and leaving it alone can
result in steady growth over time, but that’s not the right approach for
true investment growth. As an investors you must keep in mind that for
compounding interest to work, it must be fed.
Even though you can make a large return over a long period of time with a
single investment, to take full control of the potential of compounding
interest, you need to form the habit of constantly saving and contributing
at every given opportunity.
Successful long-term investors lean toward products that offer compounding
interest. Look for the APY, or annual percentage yield, which is the total
return you’ll earn over a year. Experts recommend looking for investments
with the highest yield and the most compounding periods.
THE COST OF COMPOUNDING
Unfortunately, compound interest isn’t always your friend. When you have
debt, compound interest works against you. Each month you carry a credit
card, loan, or other unpaid balance, you’ll owe the amount you’ve charged
and the unpaid interest you’ve accumulated, as well. This is why it is
important that before taking on debts, you fully understand how the interest
repayments work and are clear on different types of interest rate. The idea
here is to pay down this debt as quickly and as reasonably as possible to
keep the interest under control.
Now that you understand what is compound interest and how it can work to grow
your money, you’re on your way to taking control of your financial health.
Start now – your future self will love you for it.
What’s clear from the above examples is that you need to start NOW. Whether
your initial deposit amount is modest or not, it’s all about getting time on
your side and using that time, plus a commitment to regular deposits to
harness the power of compound interest.
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