Most financial professionals want to get across the importance of saving early, as it is the key to long-term financial success. When you start saving early, your money has more time to grow due to interest, but what the public is often misinformed about is the power of compound interest. Compound interest allows for your savings to grow beyond the amount originally set aside - the principal amount - to have exponential growth period over period.
What exactly is compound interest? Compound Interest is essentially interest earned on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously the accumulated interest. Year over year, with the interest reinvested your money grows, making it a valuable strategy for young people looking to save for retirement. “The rate at which compound interest accrues depends on the frequency of compounding: the higher the number of compounding periods, the greater the compound interest. Thus, the amount of compound interest accrued on $100 compounded at 10% annually will be lower than that on $100 compounded at 5% semi-annually over the same time period.” Read more about how to calculate compound interest, and a full overview here.
It sounds simple enough, right? Well, where things get complicated is understanding the difference between traditional interest and compounding interest. According to Investopedia, “the exponential growth occurs because the total growth of an investment along with its principal earn money in the next period. This differs from linear growth, where only the principal earns interest each period.” Of course seeking the advice of a financial professional can help you plan your strategy for taking advantage of compounding interest over a longer period of time, transforming your dreams of retirement into a reality.
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