What is Compound Interest and How Does it Work?

September 29, 2022

The Basics of Compound Interest

The term compound interest refers to returns earned on top of interest. Thanks to the miracle of compound interest, the growth of your savings account balance can accelerate gradually as you earn profits on increasing amounts of money.

The mentioned method of making your money work for you is a powerful investment tool for anyone who wants to generate funds in a quicker manner. That being said, most people are not familiar with how it works and they instead use simple interest to grow their funds. To help, we listed a few points demonstrating how compound interest works.


It Grows Faster Than Simple Interest

In addition to earning returns on the money you invest; you also get interest on top of your interest at the end of your chosen compounding period. The amount you save and accumulate can make a noticeable difference in the growth of your account.

This, in turn, gets you closer to your financial goals whether for personal use, business, or any other reason. Compounding more frequently accelerates the growth of funds and profit in your account.

Unlike with simple interest, you have the choice to either compound your interest or add it back to the principal amount. You can add to it annually, monthly, or even daily.

Calculating your compound interest is done by multiplying the initial principal amount by one, plus the annual interest rate raised to the number of compound periods, minus one. This is significantly different from how simple interest is calculated which, on the other hand, is done by multiplying the principal amount by the interest rate.


Compound Interest and How It Grows

People are encouraged to open accounts with compound interest in their 20s. If you start with 100 dollars in your account, it is possible to get 100,000 dollars or even higher in the future thanks to the miracle of compound interest.

Think of 100 dollars in an account that earns compound interest. If that money averages a positive return of at least 1% a month which is compounded monthly for 40 years, this can get you to your goals at a slow and steady pace. You can earn over 1.17 million dollars by then.


Compounding Works to Your Advantage

Starting accounts that earn compound interest can help you gather wealth and resources easily. Saving early gives you more usable funds as well as a cushion from certain wealth eroding factors. These wealth eroding factors usually vary but typically include the rise in the cost of living, inflation, and reduction in the purchasing power of a currency.


Get Help from Financial Experts You Can Trust

If you need help making more educated financial decisions, look no further than Firefighters Credit Union for next-level assistance and advice. We aim to give our members and clients the services they deserve. Reach out to us today for more details.

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