The majority of individuals come across the term ‘interest’ quite early in their lives, often in the context of bank savings or perhaps a loan. However, the concept of ‘compound interest’ is less understood, not to mention underappreciated. This financial phenomenon can act as an incredible driving force in your wealth accumulation journey.

Compound interest, in simple terms, is the calculation of interest not only on the initial amount invested, known as the principal, but also on the accumulated interest from previous periods. Think of it as ‘interest on interest’, a snowball growing larger as it rolls downhill, gathering momentum, size, and speed.

A basic explanation might sound like this: if you invest $10,000 at an interest rate of 10% annually, you would have $11,000 at the end of the first year. The second year you would earn interest on both your initial investment ($10,000) and interest ($1,000). This might not seem like a massive difference, but give it time, and the results can be huge.

Consider two hypothetical investors, Ben and Mike. Both of them initiate their financial journey with $10,000, adding an extra $500 to their account each month. Let’s say both investors enjoy an 8% return rate on their investments. The distinguishing factor, however, is the time they start investing – Ben begins at 25, while Mike starts at 35.

By age 65, the difference is immense. Thanks to compound interest, Ben’s initial investment grows to over $1.9 million. Mike, starting a decade later, accumulates a respectable but considerably lesser amount, around $835,000.

Compound interest rewards those who invest sooner rather than later. The earlier you begin, the more opportunity compound interest has to work its wonders, expanding your wealth. Remember, compound interest isn’t a quick path to riches, but a reliable, time-tested strategy for gradual wealth creation.

Bottom Line
Understanding compound interest can help you in your financial journey. With patience and time, compound interest can help turn modest savings into substantial wealth. Start investing early, contribute consistently, and let the power of compound interest carry you towards your financial goals.

George Maroudas

George Maroudas

Twitter @ChicagoAdvisor

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