What is Compound Interest, and How Can it Make You Money?

List: Posted: 01/28/11

Whenever you are looking to make the most of your investments, there are two terms that you will hear frequently: simple interest and compound interest. Let's look at what compound interest really is, where you can find it, and what benefits it offers your investments over a simple interest rate.

Compound interest, in a nutshell, is interest that is added to the principal balance of your account.  Let’s say that you have $100 in your savings account and an interest rate that is 5% each quarter.  At the end of the first quarter, interest would be added, bringing your total to $105.  With a simple interest rate, you would receive only interest on the initial investment balance in subsequent quarters, but with compound interest, the second quarter interest would be on $105 rather than $100.  While in this scenario you are only making a few extra cents, you can see how a compound interest rate nets you more money in the long run.

There are many places where you can find compound interest, including many bank accounts.  Most financial institutions offer accounts with compound interest rates.  You will also find that some investment accounts and retirement plans offer compound interest. 

 

This is certainly a good way to earn more money than with a simple rate, and it is something you may wish to look into.  Even on low balance accounts, compound interest can accrue to significant amounts over time.

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