It’s been said that the key to financial success is based on two key principles. First, work hard for your money. Then, let your money work hard for you.

The existence of compound interest speaks to the latter. And it’s exactly why compound interest is one of the safest, most effective mechanisms for growing wealth in existence.

Albert Einstein called compound interest the “greatest mathematical discovery of all time.”

But fortunately, understanding and capitalizing on compound interest doesn’t require the mental capacity of a genius like Einstein.

What is Compound Interest?

Compound interest occurs when you add accumulated interest back to the principal. As a result, interest is earned on interest on a perpetual basis thereby increasing your overall investment amount exponentially over time.

Although you can quite easily use a compound interest calculator to input the values unique to your financial situation, here is just one example of the awesome power of compound interest:

If you save one hundred dollars each month for forty years and your investment compounds at 12% annually, how much will you have? $980,000.

How Compound Interest Works

Compound Interest is often likened to the snowball effect. As your investment rolls down the hill it grows at an accelerated pace. Even with a small snowball to begin with, an exceptionally large one will result over time.

Compound Interest is based on two variables – the length of investment and the rate of return. Simply put, the longer your money is left to grow, the faster it will balloon. Similarly, the higher the interest rate you earn on your money, the higher the invested amount will become over the duration of the investment.

If you’ve ever wondered why it seems easier to stay rich than it is to become rich, it’s largely because of this mathematical phenomenon known as compound interest.

Yet, even if you are not already independently wealthy, there are simple steps that can be taken to yield big returns in the long run. For example, most people spend at least one dollar each day on some form of refreshment. Over the course of one month, however, if each dollar is directed instead to an investment account accruing compound interest at an 8% annual return, after a forty-year period elapses, you will have earned a whopping $101,372.91.

The only potential drawback associated with making compound interest the centerpiece of your investment strategy is that the rate of interest may not be the same every month. And because the rate may fluctuate (5% the first month, 3% the next month, etc.) a lot of investors still prefer to maintain the more stable and consistent – yet lower rate – of return by foregoing compound interest and, in its place, keeping their money in a simple savings account.

Making Compound Interest Work for You

Compound interest doesn’t work overnight. Throughout the duration of your investment, it is pivotal to patiently add, not withdraw from your investment if you are going to experience the awesome power of compound interest in full.

By working hard and having your money work hard for you, the path to fiscal strength and lifelong solvency will be clear and much easier to follow.

Photo by pinksherbert

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