The Importance of Compound Interest
We have all heard of the stories about investing into savings very early. And the reason people say you should do this is based on the principal of compound interest. It is all calculated based on time, so you need to get in as early as you can. The link I posted above shows you a website that will help you calculate this and understand what it is that I’m talking about. Use it to help follow along with this article.
So here is how compound interest works. You make some initial investment into a savings or retirement account. And then you want to continue investing more money into it, although you don’t have to. That is critical for your savings and earnings, but it’s not critical to this example.
So you’ve made your initial investment and you are continuing to invest more. Compound interest means that they will take the amount of money in your account and give you interest based on it. Perhaps quarterly or monthly. So you collect some interest based on how much money you already had, and that gets added back to your balance. So next time the interest compounds, you’ll have additional money to earn more interest off of. And then that gets put back into the balance, and again and again. This is how the snowball rolls and becomes bigger and bigger, especially if you are continuing to make regular investments.
So let’s run through a real world example here. You can use the calculator at the link above to try it. Let’s say you make an initial investment of $5,000 and you get an interest rate of 3%. Then you continue to put an extra $100 a month into this plan. These are reasonable numbers for real world investments and what a lot of us could actually handle.
So, here is how it would pan out over 10 years. You would start with an initial investment of $5,000, and through your regular investment of $100 a month, you would give another $12,000. Throughout the ten year period, if you could go without this money, you would earn $3,755.84. So after ten years of this, you would have a total of $20,755.84. Not bad at all, for only investing $17,000 of your own money.
Those figures are for the case that you compound monthly. If you compounded quarterly, you would end up with just about the same amount, but maybe $100 less. Now, imagine starting with a higher initial investment of $10,000, and you put in double the amount monthly, with 5% interest rates… You will end up with $47,287.36 dollars!
This is the power of the compounding interest. It is insanely beneficial to begin investing as early as you can. Serious investors with a lot of money can make an absurd amount of money just by already having money in the first place.
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