Compounding of wealth typically refers to the increasing value of an asset due to the interest earned on both a capital invested and accumulated interest. The compounding wealth, which is a direct realization of the time value of money (TMV) concept, is the most realistic way to be wealthy.
The mechanism is simple, as you grow your wealth through compound interest, you increase your wealth as a result of the interest that’s earned on top of the interest already earned.
The concept of compounding interest can be applied to particularly on fund investments. Therefore, compounding interest in investing is one of the most powerful wealth generation tools you can maximize to build wealth for the long-term.
The secret ingredient isn’t an aptitude for fund, stock, exchange-traded fund ETF, and other exchange investments when it comes to reliably building wealth.
Compounding interest considers being an investor’s best mechanism to accumulate wealth because it grows wealth at a faster rate than simple interest since it earns returns not only on your initial investment but on the interest you accumulate as well. And the longer your money has to grow, the more interest it can earn.
Some investors compare the compounding interest to a snowball, which grows bigger by rolling down a hill. The investors can take advantage of the compounding interest best by starting as early as they can.
Compound interest is different from interest rates generated from loans or bonds. The simple interest, such as interest rate, is just the interest rate multiplied by the investment or principle amount. Simple interest that is generated from a loan or bond investments can be in the context where the interest is the same every period, and there is no compounding.
How To Utilize Compound Interest To Your Advantage
The sooner you invest your money, the more you will benefit from compound interest. So, where should you invest is so important. The simplest starting point is to contribute to your employer’s 401 (k) Plan, for instance. The 401 (k) plan is a tax-advantaged retirement savings account that many companies offer in the United States. You can invest in other retirement saving accounts, such as a Roth or traditional IRA. Some of the best compound interest investments are:
- Certificates of deposit (CDs)
- High-yield savings accounts
- Bonds funds
- Money market accounts
- Dividend stocks
- Funds and ETFs
- Real estate investment trusts (REITs)
Many experts, including Warren Buffett, recommend investors to invest in low-cost index funds or exchange-traded funds ETFs, which allow you to own a small piece of many different companies. The S&P 500, for example, is a fund that holds stocks for the 500 largest companies in the United States, including Apple, Google, Exxon, and Johnson & Johnson.
An investor must understand that, no matter how you choose to invest, the most important step is to open at least one account and start contributing to it consistently to take full advantage of compound interest.
For example, the follow is an example of the growth of investment, with initial deposit of 1000 USD, monthly contribution of 100 USD and at annual 8 percent interest compounded:
| Year | Deposits | Interest | Total Deposits |
Total Interest |
Balance |
| 0 | $1,000.00 | — | $1,000.00 | — | $1,000.00 |
| 1 | $1,200.00 | $127.16 | $2,200.00 | $127.16 | $2,327.16 |
| 2 | $1,200.00 | $236.56 | $3,400.00 | $363.72 | $3,763.72 |
| 3 | $1,200.00 | $354.98 | $4,600.00 | $718.69 | $5,318.69 |
| 4 | $1,200.00 | $483.16 | $5,800.00 | $1,201.85 | $7,001.85 |
| 5 | $1,200.00 | $621.90 | $7,000.00 | $1,823.75 | $8,823.75 |
| 6 | $100.00 | $58.83 | $7,100.00 | $1,882.58 | $8,982.58 |
Calculated by the Author
How To Find a High-Yield Investment
The best investments are typically the ones that generate the highest interest rates, lower fees and meet other customer needs. The following are factors to consider when choosing an investment for compounding interest investment:
- Fees. Paying subscription, redemption or annual fees for investing can nullify interest earnings on your investments. Therefore, an investor must look for investments that charge zero or lower fees.
- Fine print. Some banks require you to meet specific monthly requirements to earn interest or to achieve a higher interest tier. Determine whether you can meet these account requirements or minimums before opening an investment account.
- High interest on investment. The best interest rates are typically found on fund and ETF investments. Also, make sure your bank offers convenient ways to deposit and access the investment accounts when you need them.
- High dividends. Choose a stock that has high dividend or fund that has both high increase rates during the last five years and low risks
- Customer service. Customer service varies from bank to bank. Choose the broker that offers multiple ways to receive customer support. Support options may include secure messages, chat, phone, and email.