What is Compound Interest?
Compounding returns is one of the fundamental concepts of investing and building
wealth over the long term
How does it work?
In an investment situation, compound interest means that each time interest is earned and is added to (or compounded into) the principal balance of an investment, it thereafter also earns interest – accumulation of interest on the interest. The more frequently interest is compounded, the faster the balance grows. Compound interest is one of the most basic and powerful concepts that can enhance the outcome of your investments.
How it affects capital growth
When you save or invest, your money earns interest, or appreciates. The next year, you earn interest on your original money and the interest from the first year. In the third year, you earn interest on your original money and the interest from the first two years. And so on.
How it works with debt
The concept works the same with an investment loan. The interest for the loan is compounded, increasing the loan balance, which in turn increases the interest amount. This interest is tax deductible, so when the interest and balance are increasing so too is the amount you can claim as a tax deduction.
Here are three steps to help you make the power of compound interest work for you.
How it improves with time
Start young. When you’re in your twenties and thirties, your best friend is TIME. Start rolling your snowball at the top of the hill and you’ll have a much bigger mass at the bottom than someone who started halfway down.