Investing 101 – compound interest

Compound interest is an important aspect of investing as it plays a big role in the accumulation of wealth. Investopedia says compound interest is:

Interest that accrues on the initial principal and the accumulated interest of a principal deposit, loan or debt. Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount.

When you make an investment that offers compound interest, the money you make in interest is added to your principal balance. Interest is then accrued on this new, higher balance. So, if you invest $100 and get 10% interest annually ($10), you would have $110 after the first year. After the second year, you would get 10% of $110 ($11, for a total of $121) instead of getting 10% of $100 again. 

The difference between interest the first year and second year in this scenario is quite small ($1). However, you can imagine how much of a difference this can make when you invest more money over a longer period of time.

This is why it’s important to start investing sooner rather than later. As you can see in Bankrate’s infographic below, the longer you wait before investing, the less time compound interest has to increase your investment.


Bankrate.com Bankrate.com retirement planning

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