Compound Interest Explained | NerdWallet

Compound interest is often referred to as magic, and when you look at how much your money can grow over time, it can sure feel that way. But the principles of compound interest are actually fairly simple. Today, we're going to go over what compound interest is and how it can help you meet your financial goals. So what is compound interest? When it comes to savings accounts, compound interest is when your bank pays you money on your balance the longer it sits in your account. Interest is paid on a regular basis, typically once a month. So each time you're paid interest throughout the year, you're earning more each time because A year might not be long enough to really appreciate the power of compound interest, but if you scale out to 5 or 10 years, or even decades, you can see how much growth can happen, even if you stop adding to your original principal balance. Let's use a $10,000 principal balance as an example with a 5% interest rate. Over the course of one year, without adding any additional money to your balance, you'll earn about $500 in interest, bringing your total to about $10,500. After 5 years at the same interest rate, you'll have about $2,800 in additional interest, making your balance about $12,800. After 10 years, you'll have earned about $6,500 in interest, making your balance close to $16,500. After a long enough period of time, say 30 years, you'll see a steep upward curve on your balance. That same $10,000 at a 5% interest rate will have earned close to $35,000 in interest, bringing your total account balance to almost $45,000, all without adding another penny to your original balance. If you do add more money to your original balance, you can expect to see an even higher rate of return over time. If you want to play around with your own numbers to see how much you can earn, look online for a compound interest calculator. This one from NerdWallet can show you your balance and interest earned over time based on how much you add to your account. So how can you make compound interest work for you? The trick with compound interest is to start early and to let your money sit in an account that earns a high interest rate. The interest rates that banks offer can fluctuate over time depending on what's going on in the economy. When the economy moves into a low-rate environment, it can be hard to find good interest rates. But even so, it's good to shop around to see what kinds of rates are available at different banks. And you may want to consider opening a new account elsewhere if your current bank's rates are subpar. Another route you can take is to open a Certificate of Deposit, which is a type of savings account that has set interest rates for a set term length. You aren't supposed to take out your money early, otherwise you'll be hit with a penalty. But if you keep your money in for the full term length, then you'll have a guaranteed rate of return. Term lengths can range from a few months to five years or more. When you're thinking about a long-term savings plan, whether it's for retirement, your child's college education, or even just your dream vacation, compound interest can be an incredibly important tool for boosting your balance. I'm Chanel Bissette, and I'm a consumer banking writer for NerdWallet. Head over to our site to check out our articles about how to find the best interest rates. And if you feel like you learned something today, hit like and subscribe.