What is compound interest?
Compounding: Interest on your interest; returns on your investment returns.
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Transcript
Compounding. Itâs when the earnings from your investmentsâincluding dividends and price growth from stocks, or interest on bonds and CDsâget added to your investment pile. Then those earnings start building upon themselves.
Interest on your interest. Returns on your investment returns. No wonder compounding has been called the eighth wonder of the world.
How does it work? Letâs compare two investors: Allie and Bill.
When Allie turned 25, she put $1,000 in her retirement plan and began adding $200 per month, every month, until she turned 65. She earned an average of 8% per year.
Bill, on the other hand, took longer to get started. He didnât get into a savings routine until age 35. He also started with $1,000 and earned that same 8% per year, but to make up for those 10 non-saving years, he put away $400 per monthâtwice as much as Allieâuntil age 65.
Who was the better saver? Letâs break it down:
After 40 years of savings and compounding, Allieâs total contributions of $96,000 grew to more than $722,000.
Bill contributed a total of $144,000, but because he only had 30 years of savings and compounding, he got to age 65 with $607,000. Thatâs still a nice sum, but Allie was able to get closer to her retirement goal, at half of Billâs monthly contribution rate, simply because she started early.
But compounding isnât always your friend. Consider credit cards and other forms of so-called revolving credit, in which you pay a high interest rateâ20% or moreâon any amount you donât pay back the first month. That interest becomes part of the total you owe, so the next month, in addition to owing interest on the initial debt, you owe interest on that interest.
Yeah. Thatâs compounding in reverse. And the higher the interest rate, the faster youâre going in reverse. Thatâs why itâs important to pay off high-interest debt as soon as you possibly can.
Want to amplify your savings? Start early. And if you hold credit card debt, whittle it down, pay it off, then swear it off.
Time is money. So money plus time equals more money. Thatâs the power of compounding.
Interest on your interest. Returns on your investment returns. No wonder compounding has been called the eighth wonder of the world.
How does it work? Letâs compare two investors: Allie and Bill.
When Allie turned 25, she put $1,000 in her retirement plan and began adding $200 per month, every month, until she turned 65. She earned an average of 8% per year.
Bill, on the other hand, took longer to get started. He didnât get into a savings routine until age 35. He also started with $1,000 and earned that same 8% per year, but to make up for those 10 non-saving years, he put away $400 per monthâtwice as much as Allieâuntil age 65.
Who was the better saver? Letâs break it down:
After 40 years of savings and compounding, Allieâs total contributions of $96,000 grew to more than $722,000.
Bill contributed a total of $144,000, but because he only had 30 years of savings and compounding, he got to age 65 with $607,000. Thatâs still a nice sum, but Allie was able to get closer to her retirement goal, at half of Billâs monthly contribution rate, simply because she started early.
But compounding isnât always your friend. Consider credit cards and other forms of so-called revolving credit, in which you pay a high interest rateâ20% or moreâon any amount you donât pay back the first month. That interest becomes part of the total you owe, so the next month, in addition to owing interest on the initial debt, you owe interest on that interest.
Yeah. Thatâs compounding in reverse. And the higher the interest rate, the faster youâre going in reverse. Thatâs why itâs important to pay off high-interest debt as soon as you possibly can.
Want to amplify your savings? Start early. And if you hold credit card debt, whittle it down, pay it off, then swear it off.
Time is money. So money plus time equals more money. Thatâs the power of compounding.