Understanding the Power of Compound Interest

Most of us need some encouragement when it comes to getting our savings in order. However there is one area of interest you may not have thought about. In fact you may not even be aware of it.

We’re talking about compound interest and the power it has to increase the amount of savings we have. Basically if you get paid interest on your savings – no matter how much it might be – you will benefit from compound interest. So let’s find out how it works.

Saving an initial amount

For the sake of ease and argument, let’s say you have a spare $100 you want to sink into a savings account. The account pays 2% in interest on an annual basis. This means by the end of the first year your $100 will have earned $2 in interest, since this is 2% of the amount you have saved.

This is where it gets interesting (if you’ll forgive the pun). Let’s assume you don’t save any more cash in year two and the interest rate stays the same. Now you’ll have $102 in your savings since you’ve added on the previous year’s interest. So if we work out 2% of $102 we get $2.04. This means we’d have a total of $104.04 at the end of year two.

Finding the best interest options

This is just an example of course but it shows how powerful compound interest can be. This is particularly true when you’re focusing on larger amounts. It’s easy to see how much you can add to your capital amount when you focus on compound interest. It’s also easy to see how important it is to find the best rate of interest you can. It will make a difference year on year the further ahead you go.

Another point to be aware of is how often the interest is calculated. If it is calculated once a day you will fare better than if it is only calculated once a month. Bear in mind it doesn’t matter how often the money actually gets paid into your account – all that matters from your point of view is how often those calculations are worked out.

As you can see, this is one more reason why you should think about compound interest when it comes to getting your savings up and running. You will be able to increase the savings you can amass over time simply by paying attention to this rule.

Some people choose to withdraw the interest on savings accounts and spend it instead of leaving it in there. However as you can see it is wiser to keep everything together so you can earn even more interest in the following years. Over time the amounts can really add up, giving you more cash to fall back on if you should ever need to dip into it. Now you know how powerful compound interest can be, you can make the most of saving with it on your side.