Compound interest is when the interest that is earned on a monetary value begins earning interest in turn. The power of compound interest can be a great thing for wealth building and a bad thing for people that carry debt. The trick is to position your finances so that compound interest is working for you, not against you. Here are some things that everyone should know about compound interest.
Why Is Compound Interest Important?
Understanding how compound interest works is important for realizing financial success. Over time, compound interest can turn a few dollars into a lot of money as long as the original balance and the interest earned on that balance are left untouched. Almost any investment will earn compound interest if you leave the earnings in the account. The longer money compounds, the faster it grows.
The Frequency Of Compounding
Compounding interest can be a double-edged sword depending on your financial situation. If you have a significant amount of money in your savings account, you will want the interest to compound as often as possible, preferably every quarter. This will help your money grow faster. If you owe a significant amount of money, you want the opposite to occur, so you should seek out borrowing options where the interest compounds annually.
Investment Options
Because the current interest rates earned on savings accounts are so low, many people get discouraged at the growth of the account. If you want your savings to grow faster, there are other options available for investing your money wisely. Some people choose to use their savings to purchase bonds that are held for a few years, and then cashed in for the original amount plus the interest earned. Retirement accounts are also good investment vehicles where you will earn a better return than with a traditional savings account.
It doesn’t matter how much you are able to save or how much debt you need to pay off; you can make compound interest work for you. A millionaire may have more investment options, but even if you have only a modest income, you can use compound interest to build a bigger nest egg or reduce the amount you pay credit card companies. Adding as little as a $100 per month to the account can result in astronomical benefits in the future. It is important to remember that interest compounds faster than you think, so you must get it working for you, not against you.