What Are the Benefits of Compounding Interest?
Compound interest can be your best friend or your worst enemy when it comes to your financial portfolio. When it comes to debts, compound interest increases the money you owe each month. When it comes to savings, compound interest is the secret to building significant wealth for your nest egg. Without compound interest, you must save a large amount of money. With compound interest, your money works and grows without your intervention.
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Interest
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Most investments offer interest payments to pay you for borrowing your money. You place money in a savings account; it earns a set rate of interest. The stock market, mutual funds and certificates of deposit all earn a set rate of return for your initial investment. For an investment vehicle earning 8 percent interest, your $10,000 contribution earns $800. Interest is computed and paid out on a set basis — monthly, quarterly or annually. The more frequently interest compounds, the better.
Return On Investment
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According to Smart Money, instead of withdrawing the $800, leave it in the account to enjoy the benefits of compound interest. The next time you get an interest payment, you receive $864 instead of the initial $800. Your balance climbs to $11,664. After 20 years, your initial $10,000 investment quadruples to $46,000. The ultimate benefit of compound interest is the ability to earn a large return on your investment over time.
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Set It & Forget It
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Among the benefits of compound interest, you don’t have to intervene. You may add extra money to your account -- and you should -- but the power of compounding on your initial investment works without you lifting a finger. You put money in the account and watch it grow over time.
Time
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Without time, your account cannot grow. Starting your investment or retirement account at the age of 25 offers a full 40 years to grow your initial investment into significant wealth at retirement (provided you retire at 65). Starting at age 55 offers only 10 years, and you notice a significantly less return on your investment. The longer your money is invested, the more it grows into true wealth. Still, it's never too late to begin.
Risk
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You get the power of compound interest with safe vehicles such as savings accounts and money market accounts but a significantly lower interest rate. By investing your money in the stock market, you can potentially enjoy the benefit of higher -- sometimes much higher -- returns on your money, but with greater risk (i.e., you can lose money, and even possibly lose your entire initial investment).
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References
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