If you are planning on retiring some day and you haven’t thought much about your investments, here’s the honest truth: you should be putting your money into a retirement account right now. Saving money is important for anyone who wants a strong financial future; however, a retirement account can give you the added bonus of compound interest, which can drastically increase how much money you make from your savings and investments. What exactly is compound interest? Let’s take a look at this financial tool and why mastering it is the ticket to success.
The Magic of Compound Interest
Compound interest is interest that will help your savings grow exponentially instead of in a straight line. For example, imagine you were investing in an account that yielded 10 percent annually. Let’s also say your initial investment was $100. That first $100 would have a return on investment of $10 for your first year, which would leave you with $110 in your account after 12 months. If you keep that $110 in your account, you will draw 10 percent interest on $110 instead of just $100. The following year would see you increase your money to $121 dollars. This is because you are earning $11 interest instead of $10. The money keeps growing for however long you have the money in your account.
Larger investments will see even bigger returns in the future. The good news is that a lot of retirement accounts are exempt from taxes until you actually withdraw the money. This means your interest will accrue tax-free as well.
Compound Interest vs. Regular Interest
An account that returned you the same amount each year leaves money on the table. Say you invested $1,000 in an account that promised you a 10 percent return each year. You would make $100 each year. After 10 years, you would have doubled your money assuming you did nothing with the money. This is because you are merely getting a return on your initial investment.
If you had an account that compounded your interest, you would end up with over $2,300 in that same account. This is a $300 increase in the return on your investment for doing nothing other than leaving your money in that account. You can see how compounding interest can make it easier to save for a long-term goal such as retirement.
How Often will your Money Compound?
There are many different schedules to determine how often your money compounds. One such schedule is the daily schedule. The interest rate is added to your balance on a daily basis under such an arrangement. Typically, the interest on your principal balance compounds monthly, quarterly or yearly. Check the investment prospectus you are provided with before investing any of your money. It will tell you exactly what will happen to your money as well as how much you should expect to return on your investment.