Compound interest: no math required!

If there's one concept you need to understand when it comes to saving and investing, it's compound interest.

Word people like me think of it this way: When you invest, your money earns a certain interest rate. And then your interest, as it's added to the pot, earns interest on itself.

Math folks think of it as a formula: 

Annual Deposit ([(1+Rate) ^Years+1 - 1]/Rate) - Annual Deposit = Total

Some financial types call it "The Eighth Wonder of the World." (Okay, maybe they need to get out a bit more.)

It doesn't matter what you call it, or whether you can do the math. In fact, a surprising new study from the University of California, San Diego and New York University, to be published in November, shows we don't need to know how compound interest works. But what we do need to know is that it does work—in a big way. The impact of compound interest is irrefutable and beautiful—it helps your money grow exponentially (aka HUGE, so long as you just let it sit and grow over time). Think of it like a sunset: You can appreciate its beauty without understanding the speed of light, right? Similarly with compound interest: you can appreciate the beauty of interest building on interest without being a mathematician.

If you're still having trouble grasping the power of compound interest, here's a quick example: If you were to save $1,000 a year from age 25 to 34 in a retirement account earning 8% a year, and never invest a penny more, your $10,000 investment would grow to $157,435 by age 65. But if you don't start saving until you're 35 years old and then invest $1,000 a year for the next 30 years (that's a total investment of $30,000), you'll have only $122,346 by age 65. The bottom line: Start early, so your money has enough time to pile up.

For now, I encourage you to try out the Compound Interest Calculator on MoneyChimp.com. (MUCH easier than the equation above!) Enter your current retirement contributions, estimate how much you'll put in each year and for how long, and—voilà—see an estimate of how much you'll have waiting for you. Not sure how much you'll need? Try the Ballpark E$timate calculator from ChooseToSave.org.

Once you have those numbers, think about your current retirement savings accounts. Ask yourself: Am I investing enough? Do I need to contribute more money? For newcomers who haven't even *thought* about retirement yet, use this as a push to get started. Enroll in a 401(k) or contribute more to it—even if it's just putting in 1% more of your salary. Think about opening an IRA (Individual Retirement Account) or adding $500 more to it this year than you did last year. Get in early and reap the benefits later—the not-good-at-math thing will just be between you and me.      



Comments

[New 2012 Medicare Advantage Plan]

Here's a simple scenario comparing simple interest against a compound interest:
Simple Interest:
First year: $1,000 x 1 year x 10% = $100 in interest
Second year: $1,000 x 1 year x 10% = $100 in interest
Total Interest: $200
Total of the principal amount plus interest = $1,200

In this scenario, the total amount of interest paid over the life of the loan would be $200

Compound Interest:

First year: $1,000 x 1 year x 10% = $100 in interest
Second year: $1,100 x 1 year x 10% = $110 in interest
Total Interest: $210
Total of the principal amount plus interest = $1,210

In this scenario, with interest compounded annually, the total amount of interest paid is $210

[grade 2 math worksheets]

The basics is the simple interest but no more simple interest in the calculations. The new name is magical compound interest "which is interest on interest". Smaller the compounding period more is the interest. Good for lender, bad for borrower (most of the times). Very good post to find compound interest using a calculator. It can help many of the users with good math skills.

Thanks for the post.
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[NICK]

I appriciate your post about how to compute compound interest but i was weak in mathematics so that time i usually prefer the online compound interest calculator which was very much usefull for me. in college there are some steps which lecturars teach me are

Steps for Calculating Compound Interest
Step 1 : Formula for calculating the total amount,
Total amount = P(1+(R/100))n.
Compound interest = Total amount - principal.

Step 2 : When the Time is given in months then:
1 month= 0.08, 2 months = 0.17, 3 months= 0.25, 4 months= 0.33, 5 months= 0.42, 6 months= 0.50, 7 months= 0.58, 8 months= 0.67, 9 months= 0.75, 10 months= 0.83 and 11 months= 0.92.