What exactly is compound interest

Compound interest is very important to understand so you can get the most out of your money. It is when you earn interest on the interest you’ve already earned on an investment. When you invest money in a retirement account you earn interest on that principal sum every period, annually or monthly. The key to compound interest is that the money earned from that interest is added back into the investment. Now you are earning interest on the principal investment, as well as on the interest earned.

For example: If you invest $10,000 and earn 10% annually, after one year you would have earned $1,000 in interest after one year. This is then reinvested to the principal sum ($10,000), so heading into year two you have $11,000. Then you would earn 10% on that, which yields $1,100 in interest after year two. This is reinvested, and the cycle continues. This doesn’t seem that important at the beginning, but this adds up. After 35 years with an investment of $10,000 at an interest rate of 10%, you would end up with $281,024. But had you invested just 5 years earlier, totaling 40 years, you would end up with over $160,000 more than that! A total of $452,593!

This is why investing early is so important. It seems like touching your investment is a long way off, but just a few extra years can make a world of difference.

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