# The Power of Compound Interest and Why It Pays to Start Saving Now

The best way to save money in the long-run. You can make the wise decision and invest in any compound interest oriented investment to hedge your financial future. (Image: via Pxhere)

The power of compound interest is way underrated. This is because most people find it hard to deposit a principal amount only to receive the accumulated interest. Tracing its roots to 17th century Italy, it’s simply “interest on interest.”

Basically, it is calculated on the principal amount and grows the sum amount at a more rapid rate than simple interest. One of the unique points of compound interest is the fact that its accrual is pegged on the frequency of compounding.

Most people don’t like numbers unless they are being added to their checks.  So we are going to make the power of compound interest and why you should start saving now as easy as possible to understand.

## First, youneed to know how compound interest is calculated

### Compound Interest Equation

A = P(1 + r/n)nt

Where:

Ø  A = Accrued amount

Ø  P = Principal amount

Ø  I = Interest amount

Ø  R = Percentage annual nominal interest rate

Ø  r = Annual nominal interest rate

Ø  r = R/100

Ø  t = Time involved in years

Ø  n = Number of compounding periods

## How often is interest compounded?

Various financial instruments have different compound interest frequencies. For example, a savings account is compounded on a daily basis, while a certificate deposit can be compounded on a daily, monthly, or semi-annual basis. Home equity loans and credit cards are compounded monthly.

All these are possible scenarios for compounding frequency. However, another important note is that these variations can be reflected in the accrued interest. This is because the accrued interest is credited on the actual existing balance. This interest can be compounded on a daily basis, but can only be credited at the end of the month.

There are some instances where some creative banks have decided to modify the concept of compounding interest. They do offer continuous compound interest. This is added to the principal amount at random instances. To ensure that it’s practical, the interest doesn’t cumulatively go beyond the daily compounded interest.

## The benefits of compound interest

The real secret of compound interest lies in the time value of money. Money isn’t “free” and has a cost that comes in form of interest payable. You may remember the all old saying that says: “A dollar in the hand today is worth more in the future.”

For instance, if you have \$200 today and decide to keep it in liquid form rather than invest it, the purchasing power will obviously decline. However, if you invest the amount or deposit it in a savings account, you will earn interest that’s pegged on the prevailing inflation rate.

Compound interest also helps you grow exponentially by sheltering you from potential wealth erosion factors like inflation and the high cost of living.

What does this tell you? The earlier you start investing, the better.

One of the best ways to squeeze more out of your investments is a mutual fund.  This is because they are flexible enough to allow you to re-invest the dividends you derive from your initial investment by buying additional shares in the fund. As this cycle continues, you continue expanding your compound interest.

## When does compound interest become your enemy?

Although the power of compound interest can tilt the playing level to your advantage, it can also prove hard to balance, especially if you have a credit card debt that carries high interest. If for example your credit card balance is \$20,000 and carries 20 percent interest rate that is compounded monthly, your total annual compound interest would be around \$4,388 or \$365 per month.

## The take home

If you are just starting off in your career, chances are that you are faced with different factors competing for your small salary. However, you can make the wise decision and invest in any compound interest oriented investment to hedge your financial future. If you are planning to be a parent, leverage the power of compound interest by saving once the child is born.

Author’s bio:

Dan Chabert — Writing from Copenhagen, Denmark, Dan is an award-winning web lover and the co-manager of several sites for your house needs and others. You can check these out That Sweet Gift, Contractorculture, The Gear Hunt, and Runner Click. He is a travel scholar time a health Enthusiast.

## To Be a True Friend, Do Not Make Jokes About These 4 Taboo Subjects

Everyone meets many people throughout their lives, some of whom become friends. Among these friends, ...

## Why Having a Wide Circle of Friends Is Good

Having a healthy body is often linked with a strict workout regimen and diet. However, ...

## China Moving Into the Arctic and Antarctic

Jens Stoltenberg, the Secretary-General of NATO, has said that the organization is carefully monitoring China’s ...

## Romance and Fortune: A Look Into the Famous Chinese Lanterns

Chinese lanterns are admired for adding an ambiance of serenity and calmness to the surroundings. ...

## The Chinese Lantern Festival

The Chinese Lantern Festival is both the climax and the last day of the Chinese ...

## Where in the Universe Can You Find a Black Hole Nursery?

Gravitational-wave researchers at the University of Birmingham have developed a new model that could help ...

## Wild Swans: China’s Cultural Revolution Through the Eyes of a Daughter

Jung Chang, who was born during the tumultuous period, witnessed the horrors of the Cultural ...

## Intermittent Fasting: The No Drama Diet Program

In the past, people rarely ate more than three meals a day. But today, people ...

## Dark Matter May Be Older Than the Big Bang, Study Suggests

Dark matter, which researchers believe makes up about 80 percent of the universe’s mass, is ...

Send this to a friend