How Compound Interest Works
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Making Money with Compound Interest
First Published: June 17, 2010 ADawnJournal.com
Compound Interest 101
When most people think about compound interest, they think about credit cards and how they lose money with compound interest. Most people hate compound interest, and they want nothing to do with it but what about if we told you that you can make money with compound interest? What about if we told you that there is the possibility to make money with something that you only think about as a bad thing?
Well, you can if you know how to use compound interest properly.
The first thing you need to do to make money with compounding interest is to start saving at a very early stage. Many experts will tell you that it is not how much money you begin to save with, but how early you begin to save. If you start saving at the age of 20, $2,000 a year, you will save $20,000 by the time you hit 30. That is much better than throwing down $20,000 at 30 and it is easier to handle on your pocket book as well. You also make more money on the money you save earlier. That $20,000 from the age of 20 to 30 will grow because of compound interest, while that $20,000 at 30 will not. The best way to look at this is with an RRSP. So let’s do some examples to show how compounding interest can work.
If someone is the age of 20 and they put in $5,000 into their RRSP, by the time the person is 65 that amount of money will have grown to $160,000 if it grows at eight percent per year. That may seem like a lot of money but it is not when you are trying to retire. Compounding interest works here because each year, the interest is put on top of the total amount in the account. Here is how:
• Age 20: $5,000 x .8 percent $5,400
• Age 21: $5,400 x .8 percent $5,832
As you can see, the interest has gone on top of the previous amount made from interest in the past year.
How do you make the compounding interest work for you then? By putting away money every single year, without fail. So, if a 20 year old puts away $5,000 every year, then by the time they retire they will have saved a staggering $1,932,528.09. That is enough to retire on! Here is how it happens:
• Age 20: $5,000 x .8 percent $5,400
• Age 21: $10,400 x .8 percent $11,232
• Age 22: $16,232 x .8 percent $17,530.56
That is how easy it is to build your investment over time using compound interest when you put money into your RRSP each year. When you do invest this way using compound interest, you need to remember three things:
• Begin the process early because the more you contribute early, the more money you can make on compound interest.
• Keep your investments regular and do not allow gaps in when you invest each year.
• Give it time to build. Do not be impatient because it is a slow process that can keep making you money if you give it the time.
