You might think you need to save money consistently, whether in a savings account, retirement savings plan, or brokerage account, if you want to accumulate more money. But if you save and invest your money wisely over a long period, you could wind up pleasantly surprised at the level of wealth you achieve.
If the idea of watching your money grow before your eyes sounds appealing, it pays to take advantage of the power of compound interest and returns.
Here we'll review what compounded growth entails and show you how a series of relatively modest contributions to a savings or investment account can evolve into a substantial sum over time.
How does compound interest work?
At its core, compounding is the concept of earning interest on interest.
Imagine you put an initial deposit of $1,000 into a savings account that pays 2% interest. That means after a year, your balance will grow to $1,020 without contributing more money.
Now here's the cool part: If you keep that money saved, you'll continue earning interest not just on the initial $1,000, but also on that $20. Assuming your interest rate stays the same, you'll earn $20.40 in interest in your second year, for a balance of $1,040.40.
After 40 years of earning the same interest in that account, your $1,000 will grow to $2,208.04 -- more than double your initial savings, with no extra investment or work.
Generally, you don't just sock away a lump sum of money and come back to it in 40 years. In reality, most people save or invest consistently. With compound interest, your principal (the money you put in) will continue to grow not only by how much you save but also by the interest that's compounding -- a double whammy of savings and interest that could help you grow wealthy over long periods.
What are the benefits of compound interest?
In a nutshell, it can grow your money. Interest means you earn money without needing to do any extra work. Then, the money you earned continues earning even more -- that's compounding. Your money continues to grow, whether you continue to add to it or not.
The downside: If you're being charged compound interest -- say, for a credit card balance -- your debt can grow just as easily (more on that below).