You’ve probably heard that time is money. Well, when it comes to compound interest, that’s definitely true. The longer your money stays in a savings account or CD, the more it grows.
Compound interest is essentially receiving interest on your interest. It’s one of the most powerful concepts in personal finance. Here’s how it works:
Let’s say you have $10,000 to sock away. So you put that money into a CD with a five-year term and 3% APY. (3% APY means you’ll earn 3% in interest per year.)
In the first year, you’ll earn $300 in interest, which means you'll end the year with a balance of $10,300.
Then the next year, you still have a 3% APY, but there’s a difference: Your starting balance is $10,300 instead of $10,000. This very same 3% APY on $10,300 will give you $309 in interest, and you'll finish the year with a balance of $10,609.
After five years, you’ll end up with a balance of $11,593, having earned $1,593 in interest just by keeping your money put.
Not bad, right?
Don’t just take our word for it. Albert Einstein reportedly called it the “eighth wonder of the world”, and you may hear financial advisors refer to the “power of compounding.” Keep in mind that interest can compound at different frequencies, commonly daily, monthly, or annually as determined by a bank or financial institution. The more frequently it compounds, the faster it grows.
Ever wonder how many years it takes for you to double your money with compound interest? This is where the Rule of 72 comes into play.
Here’s the formula:
72 ÷ annual interest rate (APY) = approximately how many years it takes for your money to double
Let’s plug in some numbers. Let's say you put $10,000 into a CD with a 3% APY. If your interest remained constant at 3% a year and left all of your money in for the full term, how long would it take for you to double your money?
72 ÷ 3 = 24
This shows it’ll take about 24 years to turn your original $10,000 into $20,000. Here's one caveat: the Rule of 72 only gives you an estimate.
The power of compounding can have an impact on many parts of your financial life. Now that you understand what it is and how it works, you can use this knowledge to help make your money work for you. You can start compounding interest today with a Marcus Online Savings Account.