Compound interest means you can multiply a small amount of money into a fortune over time.
The whole concept of saving for the future is important, but by now you have probably figured out that keeping lots of cash on hand isn’t the way to go. By carefully investing your extra cash to earn interest, your savings can multiply by a concept called compounding. Some would say that compound interest is the eighth wonder of the world because it can multiply a small amount of money into a fortune over time.
Although we’ll use small numbers in these examples ($100), you can see how the same principles work if you had $1,000, $10,000 or even more to invest.
Just how magical can compound interest be? It depends on three things:
- How much money you invest
- How much time it spends growing
- The rate of growth
As you can see, at 10% interest, you double your money in just eight years. In fact, investors frequently use the “rule of 72” to figure out how long it takes to double your money. Divide 72 by the interest rate you are earning on your investments, known as the Annual Percentage Yield (APY). For example:
72 ÷ 12% APY = double your money in 6 years
Even more magical is how this compounding of interest adds up over longer periods of time — even without adding anything more to your original investment. Compounding gets more powerful the longer it is left to work. You can easily accumulate hundreds of thousands of dollars.
The rate of growth of your investments also plays a big part in how much you’ll accumulate over time. Let’s look at three examples:
- 5% growth rate: What you might earn in a money market savings account, CD (certificate of deposit) or with bonds
- 11% growth rate: The historical average growth rate of the stock market for the last century
- 15% growth rate: What you might earn if you are an extremely successful investor
The rate of growth (interest rate) will have a huge impact on your savings. At 15%, you’ll have about four times as much money after 15 years than at 5%. At 15%, you’ll have twice as much money after 20 years than you would at 11%. Growing at 15%, a single investment of $100 can turn into $100,000 over 50 years.
Obviously, the more you invest, the more money you’re likely to end up with, too. In fact, if you started out with $1,000 instead, in 50 years, with a 15% return, your $1,000 would be worth more than $1 million.
Investing Regularly Can Boost Your Savings
By adding to your original investment, either on a yearly or monthly basis, you can dramatically accelerate this growth.
By just adding $100 to your original investment each year, you reach $6,500 in 20 years, and accumulate $168,706 over 50 years.
The point of all this is to start investing regularly — even if it’s just $100 a year — as soon as you possibly can. Then keep adding to it over the years.
Get What You Want Out of Life
Budgeting, saving, investing and spending wisely can make a big difference in your life. It can help you achieve your goals and avoid the stress of having bills pile up or having to ask others for money. It’s the foundation for building your personal wealth.
* The rates of return noted in this article are hypothetical for illustrative purposes only.
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