Know The Power of Compound Interest On Your Savings

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Time treats us both kindly and harshly. On the one hand, aging and the notion that we might need to take a break from our occupations come with time (or not). However, if you use your time correctly, it may also be highly profitable. You may be able to increase your income and experience more stability in your finances.

Compound Interest

 

We’ll look at why compound interest is such a valuable financial tool in this essay on what it is, how it functions, and its advantages. After reading this, you should have a better understanding of the long-term benefits of investing for retirement. So let’s get started without further ado.

What Compound Interest Is?

This is how compound interest functions as a financial tool. Cash and savings accounts are the two forms of money you have, and they both generate interest at various rates. Because your cash account doesn’t collect interest, you have to withdraw funds from it when you need to pay for an immediate expense, like a car repair or babysitting. However, your savings can generate much higher returns than the low rate of return your cash account receives in the form of capital gains.

Compound interest allows your savings account to grow its balance considerably more quickly than a cash account. This is so that interest is paid on both the principal balance and interest accrued over time in the savings account. You will accrue interest on your initial deposit for a period of one year, and this interest will be added to the total amount of your savings. But the following year, interest will be paid on both the initial deposit and the total balance from the prior year. Accounting-wise, it appears to make little difference: Having more money in your bank account suggests that you are also making more money each month. But when this disparity is compounded over a long period of time, such as several years, it becomes very important.

With time, these ongoing small gains will add up to a humongous amount of money in your savings account. This is why compound interest is such an important part of effective wealth building.

Let’s take a look at an example:

Let’s assume that you set aside $1,000 for yourself every year for the next 25 years. Let’s also assume that your savings account earns 5% interest per year, compounded annually. You’ll end up with $34,037 in your savings account by the time you’re 59 years old.

How does that compare with the same amount of money invested in a high-yield dividend stock fund like VIGRX, which works similarly to a savings account but with more risk? You’d have $76,965 at the same age.

The difference between these two amounts may seem small now, but when you look at it as a percentage of your total investment earnings, it’s massive. With a savings account, you’ll amass 9% of your total original investment amount by the time you’re 59. With the dividend stock fund, on the other hand, you’ll earn 3X as much — 27%.

So not only is compound interest a better alternative to cash in your savings account, but it’s also an effective way to earn more money over time. The more time you give compound interest to work for you — and the longer it has to add up small gains into larger ones — the better off you’ll be in retirement.

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