People claim that Albert Einstein called compound interest “the most powerful force in the universe.” There’s no evidence that Einstein said this, but that doesn’t detract from its power.
Interest is what you earn from investing your money. Compound interest means earning interest on your interest. It’s the force the builds dynasties of wealth over generations, as money continues to make more money.
Example of Compound Interest
Let’s say you have $10,000 in your retirement account, and your account earns a consistent average of seven percent per year.
At the end of this year, you’ll have your $10,000 plus $700 in interest. Great! That’s 700 dollars towards retirement that you didn’t have to earn yourself and then set aside. Your money is working for you.
The following year is where compounding takes off. Next year, you have $10,700 in your account, and you earn another seven percent. That means you earn seven percent on your original $10,000, plus 7 percent on the $700 in interest from last year. Interest on your interest is compound interest. At the end of this second year, you’ll have another $749 in interest, or a total of $11,449 in your account.
That $49 in additional interest in the second year ($749) compared to the first year ($700) is magic.
Compounding has a snowball effect, growing larger every year as you earn interest on interest on interest. Over time, compounding has the power to double your money without you saving another dime.
(How long does compound interest need to double your money? Use the Rule of 72 to find out.)
The secret to retiring well is to put the power of compound interest to work for you.
If you want to run the numbers on how compound interest will build your retirement savings, download the free R Minus 10 retirement calculator.
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