Basics of Investing

What is Compounding Interest?

The power of compound interest

Lots of people have a 'wish list' of things they'd like to purchase or do in the future. Starting a savings plan now will help you to achieve your long-term goals. And you may want to consider putting your money into a savings account so that you earn interest. The extra money you earn with interest payments will help you reach your goal even faster.

Compounding interest: how your money grows.

Compounding is what happens when you earn income on the money you save or invest. What does this mean exactly? Well, suppose you start by putting $10,000 into an account that earns 8% a year, compounded monthly. How much would you have after a year?

You might think you'd earn $800, which is 8% of $10,000. However, it's actually more! Every month the account earns a little interest, which is added to the amount you deposited. Then, the next month, you earn on the new combined total, and that continues every month. Your money grows faster this way, and the longer you let it compound, the more you save.

At the end of one year you would have $10,800. With simple interest, at the end of two years, you would have $11,600 because you only earn interest on the principle. After three years you would have $12,400. However, with compound interest, you will earn interest on not just the principle, but the compounded interest as well. Therefore, with compound interest, at the end of two years, you would have 11,664. After three years it would be $12,597.12 and so on.1

Whether you are saving for an upcoming trip or a car purchase in two years, saving money for future goals is always a good idea. And putting money into a savings account now will pay dividends in the future. But if you want to get to the items on your wish list sooner rather than later, think about starting that savings account today so you can achieve that goal in the short-term, rather than down the road.

1 data taken from Wikianswers

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