'Money: It's Personal' — What is compound interest?
SAN ANTONIO – You may have heard of investments with compound interest, whether it's daily, monthly, quarterly or semiannual compounding. But what exactly does it mean when you have compound interest?
The Consumer Financial Protection Bureau said compound interest is when you earn interest on both the money you've invested, plus the interest you have earned.
Let's say your investment, also known as your principal, is $5,000, and it earns a 2 percent interest rate with yearly compounding for a total of 10 years. For the first year, you would have your $5,000 investment plus the 2 percent you earned in interest. That's a total of $5,100.
After the first year, compounding comes in. Your investment will start earning interest on the interest you've already earned.
So in the second year, your investment is now worth $5,100 and it earns $102 of interest. That's $2 earned on your $100 of interest from the first year.
While it may not seem like much, after 10 years, and because of compounding, your investment would grow to $7,429.74.
Your investment continues to compound year after year, giving you even more money.
But remember, most investments carry a risk, so you have to keep that in mind when deciding to use your money.
The Securities and Exchange Commission has a tool that helps you calculate compound interest. Click here to access the SEC’s compound calculator.
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