What is Compound Interest?
Compound interest is interest calculated on the principal amount invested, which is then added to the principal amount, and compounded again. Compound interest can be earned daily, weekly, monthly or yearly. Generally the more times an amount is compounded, the more money you can make. As long as you leave an interest earning account alone, by not removing money from it, you begin making more money on your investment (given a stable interest rate) because the money you earn is added back to the principle amount. It’s a simple fact that more money earning interest makes you more money. Each time interest is compounded, the money earned gets added to the total. If you were raising two rabbits, you might view a similar thing. If the bunnies produced a litter, and you kept all those bunnies, then you might have possibly eight rabbits. The original bunnies would keep on breeding, as would the new litter, and you’d end up with more rabbits then you knew what to do with. Compound interest won
Albert Einstein, well known for being smarter than the average bear, once called compound interest “the greatest mathematical discovery of all time”. But you don’t need to be as intelligent as Einstein to understand compound interest. In fact, it is a very simple concept. The concept is this. When you invest money you earn interest on your capital. The next year you earn interest on both your original capital and the interest from the first year. In the third year you earn interest on your capital and the first two years’ interest. You get the picture. The concept of earning interest on your interest is the miracle of compounding. It’s very much like a snowball effect. As your capital rolls down the hill it becomes bigger and bigger. Even if you start with a small snowball, given enough time, you can end up with an extremely large snowball indeed. Here at the Fool, we like the concept of compound interest so much, we came up with the five Foolish Laws of Compounding. These are explaine
