How does compound interest work?

If you are making any kind of investments and if your return is added to your investment, you are benefiting from compound interest. Compound interest is a way to increase your money at a faster rate.

How does compound interest work? It works like simple math. Imagine you have a bank deposit with 6% interest compounded yearly.

You’ve got 10,000 deposited. At the end of the year, you’ll still have your deposit of 10,000 plus interest of $600 (10,000 x 6%). That’s a new deposit balance of $10,600.

At the end of the second year, you’ll have your deposit balance of $10,600 plus interest of $636. That’s a new deposit balance of $11,236. You notice that the amount of interest saw an increase of $36 from the compounding effect.

how does compound interest workCompound interest is not only compounded yearly, but it can be compounded on a quarterly basis, a monthly basis or even a daily basis.

The shorter the time period for the compounding basis, the better the terms are for you as a depositor. Compound interest helps your money grow faster.

The idea of compounding doesn’t just apply to bank deposits, it can apply to any kind of investment where the return is applied to the investment. It can apply to mutual fund investments, dividend reinvestment programs, and even real estate investments.

Now that you know how compound interest works, consider one of the more interesting peculiarities of compound interest: The rule of 72.

It works like this: When anything is compounded on a yearly basis, when the added together interest rates equal 72, then the amount is doubled. For example, if you earn 6% per year then in 12 years (6 X 12 = 72), the amount will double.

That means our mythical deposit of $10,000 at 6% interest will become $20,000 in twelve years. If the deposit is getting 8% then in 9 years it will double.

Compound interest can work for you if you allow it to. Compound interest helps your money grow faster than you think is possible. Make sure that any money you invest is compounded at the lowest time frame possible to increase your returns.