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Finance Focus Video: How does compound interest benefit you

Today’s topic is compound interest. When you deposit funds in your bank saving account, you earn intereston your principal. The bank pays interest each month on the original principal and on the interest from the prior month. Compound interes tis the result of reinvesting interest, rather than paying it out, so that interest compounds upon itself.

 

The same applies to investing in your brokerage account. Suppose you invest $100,000 by buying shares of a stock which pays you a 7% dividend every year. You have the choice of either spending those dividend payments as cash, or reinvesting those payments into additional shares. If you choose the re-investment option, reinvesting the dividends and compounding them with your initial $100,000 investment, then the returns you generate will start to grow over time.

 

Starting with the $100,000, earning 7% over 30 years, you’ll have over $750,000 vs $300,000 using simple interest (disclaimer” this is a hypothetical investment, not a guarantee).

 

There is a reason Warren Buffet calls compound interest the Eighth Wonder of the World. By saving/investing earlier in one’s life, you benefit from compoundinterest over a longer period. Starting to invest in your 20s will result in more substantially more capital in your account at age 65 then if you hadstarted in your 30s and invested the same amount annually.

 

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