## Jul 21, 2010

### The Magic of Compound Interest (Carole)

When you are investing money, there are two basic types of interest your money can earn:  Simple Interest and Compound Interest.

Quickly, let's look at the difference between these.

Simple Interest
(Interest is only calculated on the money you have invested):
If you invest \$10,000 (your principal) at 5% interest for 20 years:
\$10,000 x 5% x 20 years = \$10,000 (interest earned)
\$10,000  + \$10,000  = \$20,000

Compound Interest
(Interest is calculated on your invested money PLUS your previously earned interest):
If you invest \$10,000 (your principal) at 5% interest for 20 years with compound interest  you'll end up with \$26,532.98 .

The formula is a bit complex and hard for me to type out, but you can look it up here if you just really need to see it for yourself.

The more often  your compound is calculated (daily, monthly, yearly) the more interest you will earn.  Daily Interest = \$27,180.96
Monthly Interest = \$27,126.40
Yearly Interest = \$26,532.98

The longer your money is invested the more interest you'll earn.  Your same \$10,000 at 5% for 30 years turns into \$43,219.42   Same money, same interest for 40 years is \$70,399.89

The higher your interest rate, the more interest you'll earn.  Your same \$10,000 at 10% for 20 years will become \$67,275.00

Combine longer time and higher interest and it starts to get really fun:
\$10,000 at 10% for 30 years =  \$174,494.02
\$10,000 at 10% for 40 years =  \$452,592.56

\$10,000 at 12% for 20 years =   \$96,462.93
\$10,000 at 12% for 30 years = \$299,599.22
\$10,000 at 12% for 40 years = \$930,509.70  (yep, nearly a million \$)

Imagine if you could scrape together only \$10,000 by age 20 and find a good mutual fund that paid 12% interest (not that difficult really) and just LEFT YOUR MONEY THERE until you were 65 years old, you would have \$1,639,876.04   That's without you ever adding one more cent of principal to this investment.  The sooner you can get investing in something earning a decent interest rate, the better off you will be at retirement.

That is magic.  If you want to work some magic yourself, here is a compound interest calculator.  I'll warn you -- it's addictive!

P.S.  Your mortgage (or car payment, student loan, credit card bill. . .) works on a compound interest formula in your lender's favor.  That is why you often end up paying 3 times the cost of your house by the time your loan is completed.