![]() ![]() How Does Compound Interest Grow Over Time?Ĭompound interest can grow exponentially over time. With compound interest investments, it’s better to wait and allow these investments to grow, but with money you owe, it’s usually best to pay down debt as quickly as possible - especially if your interest rate is high. If you had taken care of the bed bugs right away, they wouldn’t have been able to multiply at such a rate. Then you discover that there are now dozens of bed bugs in your room. You could get rid of them now, but instead, you wait a few days to take care of them. Let’s say you find two bed bugs in your room. In terms of debt, compound interest can be like a pest problem. The longer the amount of time, or the steeper the hill, the larger the snowball or sum of money will grow. Like the snowball rolling down the hill, as your wealth grows, it picks up momentum growing by a larger amount each period. Much like a snowball at the top of a hill, compound interest grows your balances a small amount at first. But the longer you take to pay off your compound interest debts, the higher they will become.Ĭompound interest is often compared to a snowball that grows over time. The earlier you start saving money, the better. How Compound Interest WorksĬompound interest allows investments to work in your favor. The more frequently the sum is compounded, the faster it will grow. Interest may compound on a daily, monthly, annual or continuous schedule. You can use compound interest to save money faster, but if you have compound interest on your debts, you’ll lose money more quickly, too. ![]() After 20 years, the investment will have grown to $673 instead of $300 through simple interest. While this is a small difference initially, it can add up significantly when compounded over time. During the second year, instead of earning interest on just the principal of $100, you’d earn interest on $110, meaning that your balance after two years is $121. After 20 years, you’d have $300.Ĭompound interest, on the other hand, puts that $10 in interest to work to continue to earn more money. At the end of the year, you’d have $110: the initial $100, plus $10 of interest. If you were to gain 10% annual interest on $100, for example, the total amount earned per year would be $10. In this scenario, interest earned is not reinvested. Simple interest is when interest is gained only on the principal amount. It's important to understand how compound interest works so you can find a balance between paying down debt and investing money. Interest rates on credit card and other debts tend to be high, which means that the amount owed can compound quickly. The amount due increases as the interest grows on top of both the initial amount borrowed and accrued interest.Ĭompound interest is often calculated on investments such as retirement and education savings, along with money owed, like credit card debt. However, when you have debt, compound interest can work against you. When saving and investing, this means that your wealth grows by earning investment returns on your initial balance and then reinvesting the returns. It is the interest earned on both the initial sum combined with interest earned on already accrued returns. Compound interest is often referred to as “interest on interest” because interest accrued is reinvested or compounded along with your principal balance. It is a powerful tool that can work in your favor when saving, or prolong repayment for debts. Compound interest is the formal name for the snowball effect in finance, where an initial amount grows upon itself and gains more and more momentum over time. ![]()
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