Investing Basics: The power of compound interest and why starting early is crucial

Compound interest is one of the best methods to help increase a person’s wealth – guest post from Harry Turner

 
Most of those who invest their money will understand compound interest; however, for those who don’t, compound interest is when the value of your investment increases over time due to the interest that is applied, not only to your existing investment, but also to interest that has already been added.

Compound is undoubtedly a great way to help increase your wealth and even the best investors stand by it ; it is particularly applicable for those who are investing for their long-term wealth IE, building a retirement fund.

The more compound periods your investment experiences, the more interest you are likely to gain. On the flip side, if you have to pay debts, compound interest can actually make it more difficult for you to get out of debt because you have to spend more.
 

How is compound interest calculated?

 
If you are a business owner, this formula can be easy to understand, however for those who don’t have a business mindset, it can be more difficult.

P = C (1 + r/n)nt

C = initial deposit

r = interest rate

n = how often the interest is paid

t = how many years the money has been invested

P = is the final value of your investment/savings
 
That is the formula but putting it into simple terms. All you need to do is multiply your initial investment by one then add on top of the annual interest rate raised to the number of compound periods minus 1.
 

So why is investing so important to start early

 
The earlier you start investing the better because the more it can increase in value due to the number of compound periods it experiences. However, you do need to invest in stocks that will be around for a long time. For example, Microsoft has experienced over 40 years of compound interest rates. It is difficult to understand the number of compound periods that this company alone has experienced.

A good example would be if you deposited $10,000 in stock, let’s say the S&P 500, and it received an annual interest of 5%.In the first year, it would increase by $500, in the second it would increase by $525 and then the following year, it would increase by $551. As you can see, not only is your initial investment growing, but it is also increasing by more each year due to the interest rate it previously increased. It is guaranteed growth if in the right stocks.

Investing with an initial investment of $10,000 can be difficult for most parties however, you can start with very little and gradually increase it over a period of time. However, if you continuously invest your money into a stock or savings account, you can see this grow quicker because of compound interest. Spreading this across multiple stocks and shares is also advised as the growth rate of these stocks can vary. Just make sure you invest in stable stocks that will increase over time.
 

Compounding Interest Periods

 
Compound interest periods are something else that you will have to get your head around. This is when interest will be added to the initial interest that was added. Additionally, compound interest periods can happen more than once a year. In some instances, they could occur each quarter so therefore, it can be more beneficial to invest. Standard compound frequency occurs in savings accounts, certificates of deposits, series I bonds, loans, and credit cards.
 

Compounding Period Frequency

 
If a compound period is more frequent, it is more beneficial for the investor. That is not the case for those who are borrowing money. The more compounding periods occur, the more the borrower will have to pay.
 

The positives of compound interest

 
The positives of compound interest are very easy to understand.

● Will build long-term wealth

● Reduces the severity of wealth erosion risk

● Compounding can work for you when making loan repayments

Negatives of compound interest

● Won’t work in favour of a borrower as they can be paying more money

● Your returns are taxed

● Interest rates can vary each year, making it difficult to calculate.

If you are in debt and you can pay more off than the desired amount then you should. For example, if you are paying a debt management plan at $500 per month but one month you can pay $1000, you should because that will reduce the amount you need to pay and the interest rate.
 

Does compound interest work with investing

 
Yes, compound interest does work with investing but you have to pick the right stock. A lot of stocks can depreciate in value so you need to ensure you are investing in a stock that guarantees growth each year.

Warren Buffet has always backed compound interest and that is how it has built his investment portfolio today. In fact, Warren Buffet generated 99% of his wealth after he turned 65 which truly shows the power of his investment.

If you consider opening a brokerage account with DRIP, it will allow you to use your compound interest for your investment.

There are many stocks and shares out there that you can buy. We would advise you to choose stocks that offer a good dividend payment percentage so that you can reinvest those dividends into your investment.
 

To conclude

 
As you can see, compound interest can be quite confusing, however it can generate a lot of wealth over a long period which can help to build a large amount of wealth. People use it for

their retirement funds and help them to live their lavish lifestyle. The earlier you start investing, the more compound periods you can experience which will help you to grow your wealth. Warren Buffet started at 11 and now look at him, one of the richest people in the world and the richest investor.