The power of compound interest

What is compound interest and how can you get into it, even with no knowledge of finance?

In short, compound interest is the interest you can earn on a deposit or investment. Easy as that. The interest earned on an investment is re-invested, allowing your investment to grow at an accelerated rate over time. The “snowball effect”, of earnings on top of your original investment, will grow your wealth quite rapidly if you are able to make the right choices. The concept might be easy to understand but really seeing how much learning and relying on compound interest can impact someone’s individual finances is often underestimated.

Various areas of finance offer opportunities for building compound interest, from a savings account to investing in stock.

Can regular people get into compound interest?

Yep! Compound interest is available to anyone who might be willing to invest their money and see it grow over time. It can be a powerful tool for “regular people” to build wealth through the years.
It goes without saying that investing requires a degree of wealth and time to begin with, waiting for years for your investments to pay you back, or having the disposable income required to invest in the first place.

The most approachable tool to access the world of compound interest is through a savings or retirement account. Savings accounts that earn interest and compound it are being offered by many banks and financial institutions, both in person and online.

Mutual funds, index funds, and exchange-traded funds (ETFs) are all valid options you might want to look into. These kinds of funds allow you to invest in a diversified portfolio of stocks and bonds that, unless the stock market crashes and burns in the next 20 years, will provide long-term growth and interest.

When to start?

Yesterday, if not yesterday today. If not today, tonight. Given how time-sensitive compound interest is, starting early is one of the most important factors. The longer your money is being invested in something, the longest it has time to grow and be reinvested. Investing early might also save you money in the long run, as people who invest at year X can possibly reach their financial goal earlier and with less money than those who started later in life. Starting to save 500 euros per month at 25 and continuing to do so until retirement will leave you with about 1 million euros, at an average return of 7%. However, if you started saving the same amount per month at age 35, at 65 you’d end up with around half of that.

Consistency

Being, or aiming to be, consistent during the years is another important factor when it comes to building compound interest. Whether it’s on a bi-weekly, weekly or monthly schedule, your contribution to your investment or savings account should be cyclical. The more regular it is, the faster and more regularly it will grow. By being inconsistent and, for example, withdrawing money more frequently than you deposit it, you’ll ultimately interrupt the compounding effect and reduce the amount of interest earned over time.

The risks

Compound interest can be a powerful tool, but its power can ultimately end up working against you in the case of high-interest debt. High-interest debt, usually above 15-20%, includes credit card debt, personal and payday loans. This form of loan and debt can quickly compound and spiral out of control. The interest charged on the debt might end up being much higher than the interest earned on investment. Tackling high-interest debt needs to be dealt with as soon as possible to avoid being trapped in a cycle. If you end up having 10k of credit card with an interest rate of 20%, you would end up paying around 2k in interest.

The right assets

I know it might seem obvious, but another important factor when it comes to investing is aiming at the right assets. Duh, I know. But what does this mean? Different types of investments offer different rates of returns and different levels of risk. Diversifying your portfolio by including a mix of different assets can help you minimise risks and maximise your returns. Try to avoid “betting” all of your resources on a single asset, it might not pay off as you were hoping for.

In conclusion, compound interest is a very powerful financial tool that might help you reach your goals and allow you to set your retirement plans in advance and worry less about the future.
Start early, be consistent, avoid high-interest debt and diversify your bonds! Keep in mind that compound interest is not a get-rich-quick online scheme. It’s a financial choice that you’ll have to follow up with through the years in order to see the full benefits. With the right strategy, the right consultants and by keeping an open mind, anyone can take advantage of these tools and start setting up a future for themselves.

_{Disclaimer: This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.}