"Compound interest is the eighth wonder of the world. He who understands it, earns it... He who doesn't pays it..."
- Albert Einstein
What is compound interest?
Compound interest means earning interest on your interest. It's a powerful concept in saving and investing.
How to make the most of compound interest: 3 Strategies + Takeaways
Strategy 1: Saving the interest vs. spending the interest
What happens if you withdraw your interest as you earn it?
- Investor A makes a $1,000 initial deposit with a 5% annual return and doesn't touch his/her account. Total interest earned after 35 years is $4,516.
- Investor B makes a $1,000 initial deposit with a 5% annual return and spends the interest every year. Total interest earned (and spent!) after 35 years is $1,750.
- By leaving his/her investment alone, Investor A earned 2.5 times more interest than Investor B.
Strategy 2: Starting earlier vs. starting later
How much difference does a head start make?
- Investor A starts saving when he/she is 25 and makes a $1,000 initial deposit followed by $1,200 deposited annually with an average 5% annual return.
- Investor B starts saving when he/she is 35 and makes a $1,000 initial deposit followed by $1,200 deposited annually with an average 5% annual return.
- At age 60, Investor A will have contributed $42,000 and earned $70,900 in interest on those deposits.
- At age 60, Investor B will have contributed $30,000 and earned $29,659 in interest on those deposits.
- Investor A contributed $12,000 more than Investor B but earned $41,241 more in total interest!
The takeaway: Time is money when it comes to compound interest. The longer you wait around, the less interest you'll earn.
Strategy 3: Monthly compounding vs. annual compounding
What difference does the compounding frequency make?
- Investor A deposits $100 per month into an account that compounds monthly.
- Investor B deposits $1,200 per year into an account that compounds annually.
- Both start saving at the same time.
- Both have an initial deposit of $1,000.
- Both get a 5% annual return.
- Both contribute $1,200 a year.
- After 35 years, Investor A will have earned $76,343 in interest while Investor B will have earned $70,900 in interest.
- Even though all other variables were the same, Investor A earned $5,443 more than investor B.
The takeaway: Smaller, more frequent contributions are better than larger annual contributions when it comes to monthly compounding.
Investing can be risky: Not all investments are guaranteed — some investments carry the risk of losing money, even when made through a financial advisor or financial institution.
It Pays to Start Saving Now
Sometimes it's hard to identify your life goals, but this also means that you may have trouble saving for them too. We understand that it's tough — a lot happens between your teens and your 30s. So, we're sharing a few tips and strategies to help you better understand yourself so you can fully understand your finances and create manageable savings goals.
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