If you read our blog post, Why Interest Rocks, you learned about simple interest, the percentage you earn on the original principle in your savings account. Now get ready for the sequel... Why Compound Interest Rocks.
So why does compound interest rock, you ask?
Because this type of interest makes your savings grow even faster than simple interest.
Well, every time you earn interest on the funds in your account, that interest also earns interest.
Let’s look at an example: Say you have $1,000 in an account that pays you 5% simple interest for 1 year. You’d make $50 in interest for a total of $1,050. The following year, you’d earn the same $50 interest on your $1,000 principle, and so on. With simple interest, you earn interest on the principle amount only, so each year you will add $50 to your balance.
Total simple interest earned after 20 years: $1,000.00
With compound interest, you earn interest on your interest. So the first year you would earn $50 to bring your balance to $1050. The second year you will earn $52.50 in interest to bring your balance to $1102.50. To see how this works over time, check out this chart below that we made from this website.
Total compound interest earned after 20 years: $1,653.30
Do you now see why compound interest rocks? Click here to learn the formula for compound interest so you can calculate it yourself. To calculate how much money it would take you to reach your saving’s goal, use our savings piggy calculator by clicking here. Getting paid to save…now, that rocks!