The Power of Compound InterestSubmitted by MCF on August 10th, 2017
Remember in your mid-twenties when retirement seemed like a lifetime away, and living paycheck to paycheck was not only the norm, but your reality? ”If only I knew then what I know now” can be heard echoing throughout offices in banks around the country. In the interest of heeding that warning, it is important to understand the magic of compound interest in long-term savings, before it’s too late.
Most financial professionals want to get across the importance that saving early is the key to long-term financial success. When you start saving early, your money has more time to grow due to interest, but what the public is often misinformed about is the power of compound interest. Compound interest allows for your savings to grow beyond the amount originally set aside - the principal amount - to have exponential growth period over period.
What exactly is compound interest? Compound Interest is essentially interest earned on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus the previously accumulated interest1. Year over year, with the interest reinvested, your money grows making it an incredibly valuable strategy for young people looking to save for retirement. The rate at which compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods, the greater the compound interest. Thus, the amount of compound interest accrued on $100 compounded at 10% annually will be lower than that on $100 compounded at 5% semi-annually over the same time period.
It sounds simple enough, right? Well, where things get complicated is understanding the difference between simple interest and compounding interest. According to Investopedia, “Compounding is the process where the value of an investment increases because the earnings on an investment, both capital gains and interest, earn interest as time passes. This exponential growth occurs because the total growth of an investment along with its principal earn money in the next period. This differs from linear growth, where only the principal earns interest each period.2” Of course seeking the advice of a financial professional can help you plan your strategy for taking advantage of compounding interest over a longer period of time, transforming your dreams of retirement into a reality. To speak with an expert to find out how to make compounding interest work for you, contact us today.
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