4Q2018 | All Ages
“Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t… pays it” –Albert Einstein
This is a well-known quote in the world of investing. If it is so great, I’m sure you’re wondering why is it so great or how does it work? Simply put, compound interest allows your savings or investment to grow over time based on the original amount of money you saved plus the interest earned over time. There are 3 key components:
This is the money you will need to start your investment, or it could be the money need to make reoccurring deposits towards your investment. It does not matter the frequency, but the point is you will need some initial deposit to start your investment.
This concept is important when thinking about investing. Some investments may work better over a shorter period of time, while others may work better over a longer period of time.
Rate or Return
Based on which type of savings or investment solution you are using, you could have the potential to receive some sort of gain or profit. However, you could also have the potential to lose some money from your initial investment based on your chosen investment solution.
Let’s say you save $1,000 every year and receive 10% interest annually.
End of year 1:
- You can add the $1,000 + the 10% interest you earned on the $1,000 which is $100 of interest earned.
- $1100 is your total account balance.
End of year 2:
- You can add the $1,100 + the 10% interest you earned on the $1,100 which is $110 of interest earned.
- $1210 is your total account balance.
End of year 3:
- You can add the $1,210 + the 10% interest you earned on the $1,210 which is $121 of interest earned.
- $1331 is your total account balance.
You start getting the point – as your money grows, and if you keep receiving the same percent of interest, each year the dollar amount of interest you earn starts growing too. This is called compounding interest. This is an important concept to understand no matter what you’re saving for or investing in.
When you think about investing or saving for the future, whether it is to purchase a home, pay for your child’s college, or prepare for retirement. Compounding interest plays an important role in allowing your money to grow faster so you can meet your financial and life goals. So, like Albert Einstein said, are you earning interest or are you paying for it?
Marco Melero, C(k)P®, AIF®
Multicultural Education Strategist/ Retirement Plan Consultant
This commentary is for informational purposes only and does not constitute investment advice nor reference the appropriateness of any individual investment alternative.
Advisory services offered through Prime Capital Investment Advisors, LLC. (PCIA) a Registered Investment Advisor. Prime Capital Investment Advisors doing business as Qualified Plan Advisors, “QPA.” 6201 College Blvd., 7th Floor, Overland Park, KS 66211.