Compound interest plus patience equals wealth. It’s one of the oldest and most reliable equations in the world of finance. Even a relatively low interest rate can produce a great deal of money over time if it compounds frequently. It also generates income at a predictable rate, which is more than can be said for most other investments on the market.
How Does It Work?
Almost every bank account generates interest for the owner equal to some percent of the account’s value. Compound interest is the interest that is paid both on the original deposit and all of the interest that it has previously earned. This means that the actual interest rate paid on an account can be slightly higher than the stated value as long as previous interest payments are left in the account so that they can earn interest.
How Can I Maximize It?
There are two factors to consider in order to pick the best compound interest rate. The first thing is the nominal interest rate. The higher the rate, the more money the account will generate. The second thing to consider is the account’s compounding frequency, or how often interest gets added to the account. Interest can only start compounding after it gets added to the account, so a high compounding frequency can make a big difference. An account that receives an interest payment once per year needs to wait an entire year before it can start compounding, while one that gets a smaller payment every day can start earning interest on the interest right away.
What Can It Do?
Compound interest is ultimately a way to turn time into money. It can’t make a fortune overnight, but it can turn relatively small deposits into large savings over the years. Investments that focus on reliable compound interest also lack the risk that can come with stocks and other investment options that have the potential for faster gains. It is even possible to calculate the total amount of interest paid on any account for any interest rate, which makes it easy to predict future wealth. That makes it an important consideration for retirement planning, college funds, and other things that can build up over time. It’s also very easy to add money to most accounts that offer compound interest payments, which makes it the best option for people who can’t afford to invest large sums of money at once.