Can you guess what Albert Einstein, Benjamin Franklin, and Warren Buffet all have in common? Their love and appreciation for compound interest!
Einstein called it the “8th wonder of the world”. Benjamin Franklin described compound interest by saying “Money makes money. And the money that money makes, makes money.” And, Warren Buffett, one of the most successful investors of our time also agreed. “Compound interest is the eighth wonder of the world. He who understands it… earns it, he who doesn’t… pays it.”
What is Compound Interest?
Compound interest is the interest you earn on your money plus the interest you earn on your interest. For each compounding period, the new interest is added to your account and then the new interest is based off that total amount. Over time, compound interest will exponentially increase the value of your money.
To better illustrate this power, use our compound interest calculator to see how much money you could have in the future.
Compound Interest Calculator
Earning Money With Compound Interest
By using our compound interest calculator, you can see exactly how your money can grow over time.
Let’s say you have $1,000 to invest and you put it into an S&P 500 index fund that earns 10% a year. Let’s assume a compounding period of 1 time per year.
At the end of 1 year, you will have $1,100. Not bad, but it’s about to get interesting. At the end of year 2, you will have $1,210. That’s an extra $10 over the first year!
At the end of 10 years, you will have $2,593.74, which is a lot more than the $1,000 you would have earned with simple interest. Here is a look at how your interest increases every year with compound interest.
| Year | Amount | Annual Interest |
| 1 | $1,100.00 | $100.00 |
| 2 | $1,210.00 | $110.00 |
| 3 | $1,331.00 | $121.00 |
| 4 | $1,464.10 | $133.10 |
| 5 | $1,610.51 | $146.41 |
| 6 | $1,771.56 | $161.05 |
| 7 | $1,948.72 | $177.16 |
| 8 | $2,143.59 | $194.87 |
| 9 | $2,357.95 | $214.36 |
| 10 | $2,593.74 | $235.79 |
You can see that, at the end of 10 years, you are earning an EXTRA $135.79 per year for doing nothing different. That is the true value of compound interest. The fact that you will earn interest on your interest and make more money.
Let’s say you put $1,000 into an investment earning 10% annually at the age of 20. If you don’t touch it until you’re 65, you will have $72,890.48 by the time you retire! Not bad to make close to $72,000 off investing only $1,000.
Simple Interest vs. Compound Interest
There are two types of interest that you can earn, simple and compound. If you have a choice, always pick compound interest since it will make you more money.
Simple interest is when you earn a flat percentage of your initial investment and it doesn’t change over time. If you invest $1,000 at 10%, you’ll make $100 a year. Over ten years, your profit will be $1,000 (10 years x $100).
On the other hand, compound interest will give you interest on your interest. Your profit will increase every year since the interest is calculated off the new amount in your account at the end of each compounding term.
As you can see from above, 10% compounding interest will earn you $1,593.74 over ten years. That is a difference of almost $600 from an investment that uses simple interest.
By knowing this, always look to find investments that offer compounding interest to maximize your profit.
Types of Compound Interest Investments
One of the easiest ways to get started earning from compound interest is from your bank savings account. You probably have a very low interest rate, but it will compound every term. Over time, you’ll make more money each period as the principle increases.
Of course, to make more money, you’ll want to increase your interest rate. Stocks and bonds are also compound interest investments and they generally have higher returns. While stocks can lose value in the short term, they have historically trended upwards 6% to 10% per year over the long-term.
Here are a few of the best types of compound interest investments:
- Savings accounts, especially high-yield savings accounts
- Certificates of Deposit (CDs)
- Stocks, bonds, and index funds
- Real estate and REITs
- Treasury Securities
Check out our top 5 ways to get started investing with as little as $1,000.
Compound Interest Formula
The easiest way to calculate the future value of your investment is to use our calculator above. However, if you are interested in how to calculate it manually, here is the compound interest formula.
A = P(1 + r/n)^nt
Where:
- A: the final amount
- P: initial principle amount
- r: interest rate
- n: number of times interest is applied per time period
- t: number of time periods elapsed (usually years)
You can use this formula to manually determine how much compound interest you will earn over a set period of time.
How to Become a Millionaire by Investing
By using our compound interest calculator, we can adjust the inputs to see how to become a millionaire through investing. The awesome power of compound interest can help make you a millionaire with the right amount of time, interest, and starting investment.
For example, let’s assume you can average 10% returns per year and can invest $14,000 when you are 20 years old. By the time you are 65, you will have $1,020,466.77.
If you start investing when you are 30, you’ll have to invest considerably more to reach $1 million by the time you retire at 65. You’ll need $36,000 invested for 35 years to reach $1,011,687.73.
As you can see, the longer you wait, the more money you will need to invest to reach the same goal. If you are able to start early, try to put away some extra money that can earn with compound interest.
If you’re later in life, don’t worry too much. Just start now and make an effort to invest as much as possible.
