What does compound interest have in common with the now so popular slow-cooking? Well, the key element in both methods is time. To have time on your side, it is definitely worthwhile to start utilising compound interest as soon as possible. The more you do now, the less you need to do later on.
Compound interest is often considered a fundamental component of wealth creation. The concept is simple, yet powerful. It is your interest earning interest.
Say you deposit $1,000 in the bank. If the interest rate is 3%, you’ll have earned $30 simple interest at the end of the year. Moving forward, you earn interest not just on the original sum of $1,000, but also on the $30 in interest you’ve earned.
Interest is typically calculated on a daily basis on the daily closing balance using a savings account equation like this: Daily closing balance x interest rate (as a percentage) / 365.
And the Oscar goes to…
As long as interest rates don’t fall, the amount you receive in interest grows each year you keep your money in the bank. At first, compound interest is a cute little sidekick in the film where your initial saving sum plays the main role.
However, given enough time, the tables will turn and the compound interest you have earned may well bring home the Oscar for best actor in a leading role. It can, in fact, make a significant difference to your financial independence over the long term.
The longer you have to compound the better off you will be. Just keep in mind that your investments may not earn the same amount every year, but it is important to aim for a high average rate of return over time.
Things to be considered
- If you want to get the best possible returns on your savings balances, you need to be comparing more than just interest rates. Make sure that the investment allows capitalisation of earnings, as often as possible.
- You can only invest if you have money to invest. Do your best not to live beyond your means to have that little additional money to put to work for you. Consider starting a regular savings plan as soon as you can.