What is Compound Interest? Explained – QoreFinance

Shape of a heart with chalkboard and Compound Interest graph

If you’re thinking about investing your money, one term you may have come across is “compound interest.” You’ve probably heard good things about it (it is magical), but maybe you don’t know what it is or why it’s so great.

Let’s take a closer look at how compound interest affects your investment.

What is Compound Interest?

Compound interest is the interest you earn on interest. Confused? Here’s an example:

  • You have $200,000 that earns 10% interest each year.
  • After the first year, you’ll have $220,000.
  • After the second year, you’ll have $242,000.
  • In the second year, you earned $20,000 on your initial investment plus $2,000 on the $20,000 in interest.

That extra interest may not seem like much right now, but it will snowball over time. If you never invest another penny into that account, you will have $518,748.49 after 10 years. That’s the power of compound interest.

You can use a compound interest calculator to see how much your money can grow.

Now, when calculating compound interest, one important factor is the number of compounding periods. The higher the number of compounding periods, the more compound interest you’ll earn.

Compounding periods can be:

  • Annual (once a year)
  • Semi-annual (every six months)
  • Quarterly (every four months)
  • Monthly (every 30 days)

Let’s use the example above to see what different compounding periods will affect your money.

Semi-Annual

  • You have $200,000 that earns 10% interest every six months.
  • After the first year, you’ll have $220,500.
  • After the second year, you’ll have $243,101.25.

Quarterly

  • You have $200,000 that earns 10% interest each year.
  • After the first year, you’ll have $220,762.58.
  • After the second year, you’ll have $243,680.50.

Monthly

  • You have $200,000 that earns 10% interest each year.
  • After the first year, you’ll have $220,942.61.
  • After the second year, you’ll have $244.078.19.

Why is Compound Interest So Magical?

The magic of compound interest is that your money works for you. So even if you never add to your initial deposit, your investment will continue growing.

Depending on how much you invest and the number of compounding periods, you can grow your money significantly.

Age really is important here if you want to make the most of your investments. This chart shows the power of compound interest if you invest $250 a month at 8% return a year:

  • Age 25: $878,570 by the time you’re 65
  • Age 35: $375,073 by the time you’re 65
  • Age 45: $148,236 by the time you’re 65

The earlier you start, the more wealth you’ll accumulate. It’s as simple – and as complicated – as that. Of course, it’s not easy to find the cash every month to invest (I hear you), but these figures are motivation to find that money (cut back, get a side gig, etc.) so that you can retire someday.  You know, without financial fear and panic.

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