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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.

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