Indianapolis Recorder’s Smart Money Week continues with Everwise Credit Union explaining the power of compound interest.
Compound interest is often called the “eighth wonder of the world” by Albert Einstein, and for good reason. It has the power to turn small, consistent investments into significant wealth over time. The earlier you understand and apply compound interest, the more you can benefit from it. Here’s why this concept is so important.
What is compound interest?
Compound interest is the process of earning interest not just on your initial investment but also on the interest that accumulates over time. This means your money makes more money. The longer your money is invested, the more powerful compound interest becomes, leading to exponential growth.
Let’s say you invest $1,000 at a 5% annual interest rate. With simple interest, you’d earn $50 every year, so after 10 years, you’d have $1,500. However, with compound interest, your initial $1,000 earns interest in the first year, and the interest earned in that year also earns interest in the second year. After 10 years, your investment would grow to $1,628.89. The difference is due to compounding, which amplifies growth by earning interest on previous interest.
The key to maximizing compound interest is time. The earlier you begin saving or investing, the more dramatic the growth. For example, if you invest $200 every month starting at age 25 with a 7% annual return, by age 65, you’d have nearly $480,000. But if you wait until age 35, you’d only have $227,000. Delaying your investment costs you valuable growth.
Important lessons about compound interest:
- Start early, even with small amounts – The sooner you begin, even with modest contributions, the more time compound interest has to work for you.
- The Rule of 72 – Dividing 72 by the interest rate is a quick way to estimate how long it will take for your investment to double at a fixed interest rate. For example, at 6%, your money doubles in 12 years.
- Compounding works for debt, too – While compound interest can grow your savings, it can also work against you with debt, as credit card interest compounds and causes small balances to grow into large financial burdens.
- Automate your savings – Set up automatic transfers to savings or investment accounts to ensure consistency and avoid the temptation to spend.
Mastering compound interest can help you achieve financial independence. Starting early lets your money grow over time, giving you financial security, making emergencies more manageable, and building a stronger foundation for retirement. Passing this knowledge down can also create a legacy of wealth for future generations.
If you didn’t learn about compound interest earlier in life, it’s never too late to start. You can:
- Open a high-yield savings account, like our Boost High-Yield Savings, or start investing.
- Take advantage of employer 401(k) matching.
- Automate your savings for consistency.
- Use free resources to educate yourself.
Compound interest is a powerful tool, and learning how to harness it can set you on the path to long-term prosperity.
All examples are hypothetical and are for illustrative purposes only.
Catrina Tate is Vice President of Retail at Everwise Credit Union with 21 years of banking experience and is active in the Indianapolis community.
