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The Magic of Compound Interest

One of the ‘secrets’ of the wealthy is long-term investments that pay compounded interest. Every savvy investor, when given a choice between a good investment with compound interest and a great investment with simple interest, will pick the good investment every time. They know that, over time, the investment that compounds will outperform the other.

Here’s an example. Let’s say you have three friends; Charlie, Kim, and Sally. Each one has money to invest. Charlie has $30,000. Kim and Sally each have $10,000 to invest. Charlie places his money into a 30-year investment which pays 12% simple interest annually. Kim and Sally also put their money into 30-year investment vehicles at 12% annual interest. However, theirs’ is compound interest, with Kim’s compounding yearly and Sally’s investment compounding quarterly.

After 30 years, here’s what their accounts would look like:

* The total value of Charlie’s investment has grown to $138,000 (principal and interest).
* The total value of Kim’s investment is $299,599.22.
* The total value of Sally’s account has become $347,109.87.
* Moreover, if Sally made $50 additional deposits every two weeks during the 30-year period, her balance would increase to $755,859.58!

As you can readily see, even though Charlie had three times as much money to invest initially, the compounding investments of Kim and Sally greatly outperformed his investment in the long run. But let’s hit a little closer to home.

Most of us don’t have a large sum to sink into an investment for thirty years. What would it be like if Sally only had $100 to invest, but she could continue to deposit an additional $100 into the account every month over the full thirty years? At a more real-worldly compounded rate of 8%, let’s see how she’d fare:

* After 30 years, Sally’s account would be worth $150,129.52, which still outperforms Charlie’s investment!
* If she deposited $25 weekly instead of $100 monthly (only $50 more per year), her balance after 30 years would be $165,034.94!

You get the picture. The point is that compounding interest works, and works well. If you’re not using it to maximize your money, then get to it. You don’t have to start with much; you simply have to be consistent. But you must start. Every day that you don’t have this powerful principle in your financial arsenal is money that you’re losing in the long run. Use the compound-interest calculator to play with the numbers yourself. It’s just like magic; so what are you waiting for?

  1. faiza
    4 April 2011 at 12:46 pm

    how to start & where. can you recommend?

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