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Investment 101: What is compound interest?

Investment 101: What is compound interest?

Compound interest is when your money earns interest, and then that interest also earns interest. It will supercharge your savings – and your debt.

2 July 2024

Let’s say you’ve saved $10,000. Top job.

If you earned simple interest of 5%, you’d earn $500 a year on top of your $10,000. After 5 years, you have $12,500. After 20 years, you have $20,000. You’ve doubled your money.

Compound interest supercharges your savings. After your first year you earn 5% not only on your original $10,000, but also on the interest you earn. After five years, you have roughly $12,760. In 20 years, you have $24,880. You’ve made nearly $5,000 extra because your interest is earning its own money.

The gap just keeps widening – the earlier you start, the faster it grows. This is why vampires are always rich: if you invested $100 in 1800, at a 5% compound interest rate, it would now be worth $2.15 million without you ever having put in another dollar.

Remember, the same applies to debt. The longer you take to pay off a loan, the more the debt compounds, and the more it costs you. The lesson here? Even if you are a vampire, don’t take 224 years to start paying off your $100 debt or it will be looking pretty unmanageable.

Informed Investor's content comes from sources that Informed Investor magazine considers accurate, but we do not guarantee its accuracy. Charts in Informed Investor are visually indicative, not exact. The content of Informed Investor is intended as general information only, and you use it at your own risk.

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