How Compounding Interest Helps Me


You do not have to place a large amount of money into highly volatile stocks to make money. You can, but if anything that is the surefire way to lose your hard earned money.

Your investments do not need to return 20% or more to make you wealthy. By investing small sums, and making average gains you can increase your wealth. Understanding compounding interest will make you a safer and more wealthy investor.

The return you receive on an investment is interest. If you invest $20,000 and it returns a modest 10% a year then you will have earned $2,000 in interest. Compounding interest is the escalating effect of interest. As an example, if your $20,000 investment was returning 10% per year after 10 years you would expect to receive $20,000 in interest. Actually it is much more than that; over 55% more than that. Compounding interest ensures the amount you earn is more.

After Year 1 you receive $2,000 which makes your investment $22,000. For Year 2, 10% of $22,000 is $2,200. This means the amount of interest you receive in year 2 is greater than year 1. This interest you are earning is compounding. Every year, your investment compounds more and more. After 5 years your investment of $20,000 has gone up to $32,210. That is interest of $12,210 not $10,000 as you first thought. At the end of 10 years your investment is worth $51,875. You have returned $31,875 and not $20,000. This shows the power of compounding interest.

This is one sum of money invested over 10 years with no contributions and earning modest returns. Understanding compounding interest, and that investing for retirement is a long term investment strategy, will put you on the right road to retiring on a comfortable amount of money.

 

Information is for educational and informational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.

Categories Investing and Financial Planning, Retirement Tags

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