When you earn compound interest on a balance in a savings or investment account, the interest you earn on that balance is reinvested, earning you even more interest. Compound interest helps your savings and investments grow faster over time. On the other hand, it increases the amount of debt you owe over time.
Compound interest is a beautiful thing, and here is all you need to know about it.
You don't merely earn interest on your principal balance when you use compound interest. Even your interest is compounded. When you apply earned interest to your principal balance, you earn even more interest, compounding your profits.
The increase of your savings account balance would accelerate over time as you earned interest on greater and higher sums, thanks to the power of compound interest. You'd end up with a balance of $4,321.94 if you left $1,000 in a savings account for 30 years, receiving a 5% annual interest rate the entire time and never adding another penny to the account.
At different time periods, interest can be compounded—that is, added back into the principal. Interest, for example, can be compounded annually, monthly, daily, or even indefinitely. The faster your principal balance grows, the more frequently interest is compounded.
Continuing with the previous example, if you started with a $1,000 savings account balance and collected interest daily instead of annually, you'd wind up with a total amount of $4,481.23 after 30 years. If interest was compounded more regularly, you would have earned an extra $160.
You should recognize a few crucial elements when calculating compound interest. Each plays a unique part in the final product, and some variables might have a significant impact on your profits. Here are the five main variables to consider when learning about compound interest:
Interest - This is the rate at which you earn or are charged interest. The more money you make or owe, the greater the interest rate.
First principle - How much money do you have to begin with? How much money did you borrow? While compounding accumulates over time, it is entirely predicated on the initial deposit or loan amount.
Compounding frequency - How quickly a balance rises is determined by the rate at which interest is compounded—daily, monthly, or annually. Make sure you understand how often interest compounds before taking out a loan or starting a savings account.
Duration - How long do you think you'll keep an account or pay off a loan? The longer you leave money in a savings account or keep a debt open, the more it will compound, and the more you will earn—or owe.
Deposits and withdrawals - Do you plan to deposit money into your account on a regular basis? How often will you pay back your loan? In the long run, the rate at which you build up your main debt or pay off your loan makes a major difference.
There are so many resources to understand compound interest. Check out https://www.investopedia.com/terms/c/compoundinterest.asp
Investopedia has the answer to pretty much every financial question you have. I will provide many other resources in the future as well.
As always, contact me with any questions you have!