Money & You

The power of compound interest: How to grow your wealth over time

May 6, 2023

Are you interested in unlocking the potential of your savings and growing your wealth over the long term? Let us introduce you to the concept of compound interest, a powerful tool that can play a crucial role in the growth of your wealth and your ability to avoid going into debt.

What is compound interest?

Compound interest is like a money snowball. It's when you earn interest not only on the money you first put in (called the principal) but also on the interest that adds up over time. This helps your money grow faster and faster, just like how a snowball gets bigger as it rolls down a hill and picks up more snow.

Here's a simple way to understand how compound interest works:

  1. You start with some money, called the principal.
  2. You put that principal into something like a savings account.
  3. You earn interest on the principal based on a certain interest rate.
  4. The interest you've earned is added to the principal.
  5. Now, you earn interest on the new, bigger principal (including the interest you've already earned).

Let's look at an example. Imagine you invest $1,000 with a yearly interest rate of 5%. 

Year Principal at Start of Year Interest Earned Total at End of Year
1 $1,000.00 $50.00 $1,050.00
2 $1,050.00 $52.50 $1,102.50
3 $1,102.50 $55.13 $1,157.63
4 $1,157.63 $57.88 $1,215.51
5 $1,215.51 $60.78 $1,276.29
6 $1,276.29 $63.81 $1,340.10
7 $1,340.10 $67.00 $1,407.10
8 $1,407.10 $70.36 $1,477.46
9 $1,477.46 $73.87 $1,551.33
10 $1,551.33 $77.57 $1,628.90

As you can see, the interest earned each year increases as the principal grows due to the addition of interest. After 10 years, the initial $1,000 investment has grown to $1,628.90, thanks to the power of compound interest. The longer the investment is held, the more significant the effect of compounding becomes!

Why should you care about compound interest?

  1. It can help you grow your wealth over time.
  2. It rewards long-term thinking and patience.
  3. It takes advantage of time in the market, rather than trying to time the market.

How to make the most of compound interest

Compound interest can be really powerful and there are lots of common methods and tricks that people use to make the most of it.

  • Start early. The longer that principal is earning interest, the more it compounds, and the more money is generated.
  • Invest regularly. More contributions to those savings means a larger amount of cash that’s compounding and - you guessed it - the more money is generated.
  • Reinvest your earnings: Rather than pulling out the cash, some people “let the interest ride” so that it keeps compounding as much as possible.

Summary

Compound interest is a powerful financial force that can help grow your wealth over time, but like all things money, it requires work - and plenty of patience. Understanding compounding interest is a great place to begin, but make sure you speak with a registered financial advisor if you have any questions about whether it’s the right option for you.

This was originally posted as an education article on the Money Sweetspot customer portal. If you read this as one of our customers, you would've earned some money off your loan! Do the mahi, get the treats. Find out more.

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