Compound Interest
The great Albert Einstein described compound interest as the eighth wonder of the world.
“He who understands it, earns it; he who doesn’t, pays it”
COMPOUND RETURN VS. SIMPLE RETURN
Explaining the difference between compound return and simple return will help you understand the investing concept.
Simple interest is where you earn interest only on the initial sum of money. Compound return is where interest that you earn on a sum of money is re-invested so that you earn interest on the initial amount of money, plus interest on the interest.
What is compound interest?
At its most basic level, compounding is the process of growing or building upon itself – the snowball effect!
Compound interest is interest paid on the initial principal (the original sum of money you’ve invested, or the amount borrowed or still owing on a loan), as well as the accumulated interest on money you have invested or borrowed.
You earn interest on the money you deposit, and on the interest you’ve already earned – in other words, you earn interest on your interest.
Put simply, compounding interest means you earn interest on your interest.
So while you have to work to earn the money you initially invest, from there on the money does all the work for you.
To get the most out of compounding interest, there are three golden rules:
Reinvest (save) the interest
Think long term
Keep adding money
One of the key ingredients in compounding interest is time.
Throw time into the mix and compounding becomes a serious money-making weapon. The longer you leave your nest egg to grow, the bigger the effects on your money.
Just like getting over a breakup or waiting for your plants to grow, when it comes to compound interest – it takes time.
It’s an effective way to build enormous wealth, but it’s definitely not a get-rich-quick scheme.
The sooner you understand the power of compound interest, the sooner you can put it to work for you.
BENJAMIN FRANKLIN LEFT $2,000 TO BOSTON AND PHILADELPHIA, 200 YEARS LATER IT BECAME OVER $6.5 MILLION
Benjamin Franklin provides us with an actual example.
When Franklin died in 1790, he left a gift of 1,000 pounds sterling to each of his two favourite cities, Boston and Philadelphia.
He stipulated that the money was to be invested and could be paid out at two specific dates, the first 100 years and the second 200 years after the date of the gift. After 100 years, each city was allowed to withdraw 75% for public works projects, with the remaining 25% of capital to be reinvested for another 100 years.
After 200 years, in 1991, they received the balance—which had compounded to approximately $4.5 million for Boston, while the money in the Philadelphia account was valued at $2 million. The large difference in the value can be traced to the wiser handling of the investment in Boston.
Franklin’s example teaches all of us, in a dramatic way, the power of compounding.
“MONEY MAKES MONEY.
AND THE MONEY THAT MONEY MAKES, MAKES MONEY”
Benjamin Franklin
Compound interest is one of the most important financial concepts to understand if you want to watch your money grow. Having a good grasp on what compound interest is and how it can boost your savings is something we think everyone needs to know. If you can understand the benefits of compound interest earlier in life, you’re a lot more likely to reap the rewards of it later on.
Our Newcastle Advisors are waiting to explore the options available to your specific circumstance to take advantage of compound interest