Looking for an easy way to build wealth? The "magic" of compound interest might be the trick you're looking for.
Compound interest is when you earn money on a principal investment, and the interest you've made on that principal sum—you're earning interest on interest. Have we piqued your interest yet?
How it works: Let's say you've got $10,000 (the principal) to invest and you earn 5% interest. After the first year, you'll have $10,500.
- If you leave that money untouched, in the second year, you'll have earned another $500 on the principal, but you'll have also made $25 on the $500 of interest you accrued in your first year. Your total for year two will be ~$11,025.
- If you left that $10,000 and its compound interest for ten years, you'd make ~$6,288.95 in interest. After 30 years, you'd have ~$33,219.42. This calculation is based on interest compounding annually.
- The power of compound interest is that it grows your money faster than simple interest, where you're only earning interest on the principal.
The formula for compound interest is A = P (1 + [r / n]) ^ nt.
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A is the amount of money accumulated, P is the principal amount, r is the annual interest rate, n is the number of times interest is compounded in a year, and t is time measured in years.
- But you could use this handy compound interest calculator if you're not a math head.
Compound interest can also work against you, though. In the same way it can grow your money, it can also increase your debt quickly, as accumulated interest snowballs into an unmanageable amount.