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

**Simple Interest**

*(Interest is only calculated on the money you have invested):***$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):***$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.

*In addition:*

*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.

## 2 comments:

I sure wish this would be taught in high school. I think in some classes it might be touched upon, but I don't think it is fully explained why it is so important to know.

Thanks for the link.

Could you also do a post about how you go about finding a mutual fund and what a mutual fund actually is? Thanks.

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