Yes, according to Einstein, compound interest is on par with the Great Wall of China and the Colosseum in Rome. That being said, it’s probably not a bad idea to learn a thing or two about it.
Let’s start with what it is.
Compound interest is defined as the interest calculated on the initial capital as well as on the accumulated interest from previous periods.
So basically “interest over interest”. You get interest on the amount of money you originally invested and then interest on the interest you earned on that. It’s almost like your money is working for you. A very nice bike.
This is quite different from simple interest, which is only calculated on the basis of the original principal amount, so that it is unable to gain that fast growing snowball momentum that makes interest compound so lucrative.
The key to compound interest.
If compound interest is the key to building wealth, then what is the key to compound interest?
According to some people who know what they’re talking about (like Ron Lieber, Your Money columnist at The New York Times), the key to compound interest is time. The fact of the matter is when you start to save often exceeds the amount you save.
This painting changed my life. pic.twitter.com/N3xX6Bhcn4
– (((Ron Lieber))) (@ronlieber) May 18, 2017
It is therefore never too early to get started. As in you should start now. Right now.
How to start.
First of all, you want a savings account. Savings accounts tend to offer higher rates than checking accounts, so look for them to snowball. Take a look at the interest rates offered by several different banks and be aware that it can also be referred to as APY (Annual Percentage Return). You can also earn compound interest on certificates of deposit and money market accounts.
The medium bond works like this: you pay a lump sum up front to a bond issuer and the issuer then pays you interest regularly (i.e. every six months) and repays you your initial investment when the bond matures on a predetermined date. But if you are looking for a compound interest bond, look no further than a zero coupon bond. The downside to zero coupon bonds is that they don’t earn you any interest in the interval to maturity. But the benefit is substantial: you buy the bond for less money than you will receive at maturity, and the amount at maturity reflects the compound interest earned. There is a whole formula for this, but we won’t go into that here.
Composition doesn’t always have to go with interest. It can also be found in the area of investing. If you have a stock in a company and you use the dividends from those stocks to reinvest in other stocks, those stocks will also increase and start producing their own dividends. Another cycle, but this one requires a little more work but also a little more return.
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