Photo by Austin Distel on Unsplash

Understanding Compounding Interest Will Save Your Retirement

Compounding interest is a great way to increase one’s wealth. However, most individuals know little to nothing about the real power of compounding interest. If you want to build wealth, you must understand how compounding interest works and how a one percentage point of interest can have a significant effect on your savings.

Many wealthy individuals earn their money from accumulating interest. Today, we’re going to go over just how much money one can gain when their money accumulates interest.

Compounding interest works like this, the interest you’ve earned from your principal amount is added back to your principal. For example, if you started with $1,000 of saving and it made interest 10 percent in a year. You would have a total of $1,100 by the end of the first year. At the beginning of year two, your principal amount is now $1,100.

Assuming the interest rate stays the same, by the end of year two, your account would have a total of $1,210. It’s a slow start, however; it’s not a bad start. If we wanted to know how much we’ve earned in thirty years or longer, we could use the compounding interest formula or calculator.

Now that we know the formula let’s see how much $1,000 would earn at 10 percent a year over thirty years. The total would be $17,449, not bad. If we go out another thirty-five more years, the total would be $490,370. Whoa, talk about a huge leap! As you can see, the longer the money earns interest, the faster the growth. In fact, it grows as an exponential growth rate rather than a linear growth rate.

Every Percentage Point of Compounding Interest Matters

Furthermore, let’s change the formula a bit. Instead of a 10 percent rate, we’ll replace it with 9 percent. The total amount we receive from a 9 percent compounding interest for sixty-five years is $270,845. Wow, we’re talking about a little more than half of the 10 percent’s total. As we can see one percent over a long period can make a huge difference.

Now that we know that compounding interest can be a great way to accumulate wealth, the question is, what is the best way to earn compounding interest? Unfortunately, banks are not a great source of earning worthwhile compounding interest. The best they tend to offer is .1 percent, yes that’s right .001 interest.

A better source would be to purchase corporate or municipal bonds. The rate on the bonds varies according to the stability of the business or local government. The riskier the bond, the more interest earned.

However, the best source of receiving a high rate of interest is from the stock market. In fact, the stock market is the best way to grow wealth, even better than real estate! I know, I know, you may not like the idea of investing in the stock market.

Yes, the stock market can be risky, but this applies to everything when it comes to building wealth. But if you know how to invest, you can minimize your risk and still receive high returns, and even beat the index funds!

Start Compounding Right Away!

If you don’t like the idea of trying to find valuable companies to invest in, you can always look for a mutual fund. A mutual fund is operated by professional money managers, who allocate the fund’s assets in an attempt to produce positive returns for the fund’s investors.

Just be aware of the operating fees, because like your compounding interest growing exponentially, mutual fund operating costs also increase exponentially. So it’s essential to look for a high performing mutual fund with a meager expense ratio, preferably nothing over 1 percent.

If stocks and bonds sound too risky, you can try opening a CD saving account through your bank or even online. Companies such as Capital One offers an online 2.50 percent CD for five years. Your money will be locked into the account until the period expires, however; this method tends to be a lot safer than stocks or bonds.

But of course, the more reliable the investment, the lower the rate of return on your money. Personally, I prefer doing my own stock investing, but you should choose your personal risk tolerance.

Regardless of which method you choose to compound your interest, the key here is not to underestimate the power of compounding interest. Start compounding your money as soon as possible. As the math shows, the sooner you start, the more wealth you accumulate!


Leave a Reply

Your email address will not be published. Required fields are marked *