Compound Interest
Money growing on top of both the original amount and previously earned interest, like a snowball getting bigger as it rolls. π°
Brief Introduction
Compound interest is when you earn money not just on your initial savings, but also on the interest you've already earned. It's like having a money-making machine that gets more powerful over time. This is how many people grow their wealth through savings accounts, investments, and retirement funds. π±
Main Explanation
Interest on Interest π
Unlike simple interest that only grows from the original amount, compound interest creates earnings on both your initial money and accumulated interest. It's like a tree that grows new branches, and then those branches grow their own smaller branches.
Time is Your Friend β³
The longer you leave your money to compound, the faster it grows. It's like a domino effect that gets bigger over time. The growth starts slow but accelerates as time passes, which is why starting early is so important.
Frequency Matters π
Interest can compound daily, monthly, or yearly. The more frequent the compounding, the more money you earn. It's like watering a plant - the more regularly you water it, the better it grows.
The Rule of 72 π
A quick way to estimate how long it takes money to double: divide 72 by the interest rate. For example, at 6% interest, money doubles in approximately 12 years (72Γ·6=12).
Examples
- If you put $100 in a savings account with 10% annual compound interest, after one year you'll have $110. The next year, you'll earn interest on $110, not just the original $100, giving you $121. π΅
- Think of a small snowball rolling down a snowy hill. As it rolls, it picks up more snow, getting bigger, which then helps it pick up even more snow - that's compound interest in action! β
- Plant two trees: one in your backyard, one in your friend's. Your friend cuts their tree's new branches yearly (simple interest), while you let yours grow naturally (compound interest). After several years, your tree will be much larger because each new branch supported the growth of more branches. π³