It has been known as the 8th wonder of the world according to Albert Einstein who once said; he who understands it earns it… he who doesn’t pays it. But, the real question is; what is compounding interest?
We are finding that more people are unsure about the concept of compound interest and how this can benefit them so here is a quick snapshot of what it is.
“Compounding interest is when you have your original savings which is earning interest then you earn interest on both the original savings and on the interest. Put simply its interest earning interest.” Sam Robinson, Director of Pursue Wealth
Here is an example of how compounding interest can help you:
Let’s say that you absolutely killed it at work last year and earned a $2,000 bonus a year ago. If you put that bonus in a high-interest savings account last year earning 5% interest, you would have earned about $100 interest so this year you will earn interest on the $2,100. If you then earn 5% on your $2,100 you will have earnt approximately $105 in interest this year so will have a total of $2,205. Your interest is now earning you interest- it is compounding!
Some of the benefits of compounding interest are;
- Your money to working for you
- The more time you have the more momentum you build (it’s like a snowball effect!)
- You make interest on your interest
- The rich get richer due to understanding compounding interest
Just be careful! Adversely, compounding interest works in the same way with debt. This could be credit card debt, personal loans, car loans or home loans, this will work in the banks favour particularly if you are only paying down minimum repayments. You will then be paying interest on the accrued interest amount.
Like always, if you have any questions please feel free to touch base with us!