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What is compound interest?

Compound interest is the interest you earn on interest. Over time, whether you deposit one lump sum or are able to deposit money to an account on a regular basis, you can benefit from the “the miracle of compounding.”

Here’s how it works. If you have $100 and it earns 5% interest each year, you’ll have $105 at the end of the first year. At the end of the second year, you’ll have $110.25. Not only did you earn $5 on the initial $100 deposit, you also earned $0.25 on the $5 in interest. While 25 cents may not sound like much at first, it adds up over time. Even if you never add another dime to that account, in 10 years you’ll have more than $162 thanks to the power of compound interest, and in 25 years you’ll have almost $340.

Start saving early if you can! Even if it’s a small amount, when it comes to compound interest, time is on your side.

Here’s an example to show the benefit of starting early:

Sam invests $200 per month for 20 years. He then stops investing and lets his money compound for the next 20 years.

Jack skips the first 20 years of saving, but then contributes DOUBLE the amount per month ($400 per month) for the next 20 years.

At the end of the 40-year investment period …

Sam has $210,560. His total investment was $48k

Jack has $158,716. His total investment was $96k

*(Calculated on the SEC Compound Interest calculator for this example only and was based on 5%, compounded once yearly.)

Another point to keep in mind … when comparing deposit interest rates, always compare on the basis of the Annual Percentage Yield (APY). The APY allows you to compare “apples to apples” as it takes into consideration how the interest is calculated and how often it is compounded.

Want to see how compounding can benefit you? Try our savings calculator or certificate of deposit calculator to see for yourself.

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