#FINANCES FOR DUMMIES COMPOUND INTEREST HOW TO#

Overall, compounding is an effective long-term wealth-building strategy that can generate impressive returns given a steady rate of return over a long-term basis. This process is known as the power of compounding and can yield impressive returns over extended periods of time., This means that, if left untouched, the returns generated over time can grow exponentially and become quite sizeable over a long period of time. One advantage of compounding is that the returns generated can compound indefinitely. As such, compounding is a method of generating wealth on a long-term basis, allowing returns to accumulate over time. This, in turn, can generate larger returns than would be generated simply through the investment of capital in a single lump sum.

#FINANCES FOR DUMMIES COMPOUND INTEREST HOW TO#

See also: How To Find The Best Dividend Stocks - 5 Key Things You Must KnowĬompounding works by reinvesting the returns generated from an asset into the same asset over time. Compounding has been used for hundreds of years as an effective wealth-building strategy and is one of the oldest and most effective ways to generate wealth. It is the process of reinvesting the returns generated by an asset to grow over time. Interest RateĬompounding is an ancient financial concept that has been around for centuries. Even half of a percent can change the big time the total amount you need to pay for your mortgage loan, just because it is for a long period of time, usually 20-30 years. Even a small difference can make a big impact over time, in the long run. So, the most important thing when you invest is to get the maximum interest rate you can. Just see what you would have after 20 years if you invest just $100, but at a 40% interest rate: This is the real power of compounding, I think I explained it well and now you got it. Your $100 buck would grow to the astonishing amount of $3,833.76 In the table below you can see the three examples together. Using again the same example, if you double one more time and make the 10% rate 20%. If you double the interest rate, your ROI more than doubles if everything stays equal See also: What Is A Stock Market Crash? When Do Market Crashes Happen And How To Predict Them? You can use it to plan the growth of your savings and make some more complicated compounding calculations. This is cool, isn’t it? If you would like to make your own calculations with different percentages and amounts, you can try our nice investment growth calculator. The results are amazing, after this period of time your initial investment of $100 would become $265.33 and you would have realized 165.33 % total ROI (Return On Investment). In the following table, you can see how your investment would grow if you waited for 20 years.

Every next year your profit increases more, and more, and more. After the 4th year, your profit will be $5.79, and so on, and so on. It increases again and the best thing is that you do nothing about this, you just wait for another year. If we continue the example if you leave your investment in the bank one more year (third), your profit will be $110.25 * 5% = $5.5125 and you will have 115.76 in total.

See also: What Are Dow Jones Futures? How To Invest In Futures In compounding, the interest after each year is capitalized, becomes an addition to the initial investment, and starts earning interest itself. It’s magical because your profit gets bigger and bigger every next year without the need to add anything to your initial investment. This is what compound interest actually is. In the second year, you get $0.25 more profit than the first one and this is why you get interest on your interest of $5 from the first year. This is where compound interest turns on, compare your profits after each of the two years. You start the second year with $105 and at its end, you will have again a 5% profit.ĥ% x $105 = 0.05 * $105 = $5.25 profit. It’s activated if you decide to leave your profit ($5) in the bank and wait another year. You have $105 at the end of year 1.īut what about compound interest? It doesn’t come into play in this situation. If you have $100 and put it in a bank account for a year at 5%, at the end of the year you get:ĥ% x $100 = 0.05 * $100 = $5 profit.

Finances for dummies compound interest