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Invest Smarter: Take Advantage of Compound Interest
In this section, we help you be a better educated investor. Let's start with a basic concept—compound interest. When you invest money it earns interest. When those earnings get added the original investment, you start earning interest on the original investment and original interest. This is how compound interest works. As this goes on year after year, compounding creates a snowball effect. Therefore, your initial investment works much harder for you.
For example: You put $1,000 in a money market account earning 5% each year, or 1.25% per quarter. Let's see how compound interest increases the amount of your yearly earnings:
| Quarter | Beginning Amount | Rate | Quarterly Earning | Total |
|---|---|---|---|---|
| 1 | $1,000 | 1.25% | $12.50 | $1,012.50 |
| 2 | $1,012.50 | 1.25% | $12.66 | $1,025.16 |
| 3 | $1,025.16 | 1.25% | $12.81 | $1,037.97 |
| 4 | $1,037.97 | 1.25% | $12.97 | $1,050.94 |
After a year, your $1,000 has grown to $1,050.94. This means your compound interest rate was 5.094%, not 5%!
See
the impact of compound interest on a lump-sum investment.
Calculate
the future value of a monthly investment.