Is Compound Interest a Good Investment?
Personal Finance

Is Compound Interest a Good Investment?

Story Highlights

Making the Most of Your Money

Everyone is searching for high-returns on their investments, preferably with as little risk as possible.

Though compound interest is not a type of investment in and of itself, it is a great way to maximize your gains. This holds true regardless of where you decide to place your money.

Compound interest is more than a good investment. It is an essential part of a winning strategy for creating long-term wealth.

The Secret of Investing Success

The name Warren Buffett is synonymous with fabulous investment success. While most of us have more modest goals and ambitions, there are plenty of insights that we can all learn from the “Oracle of Omaha.”

“Our favorite holding period is forever” is among his more famous mantras, which testifies to the virtue of the patience that is a cornerstone of Buffett’s investing philosophy.

Compound interest is one of the principle reasons that this strategy has been such a boon for Buffett. Over the course of his illustrious career, he has continued to re-invest his gains. Over time, this has allowed him to continue using his profits to accumulate enormous overall wealth.

Calculating Compound Interest

To better understand how compound interest can work for you, consider the following two investors.

Josh invests $1,000 in a 12-month certificate of deposit that is offering a 7% annual return. After one year, his initial investment is now worth $1,070 dollars. Josh is happy; he’s made some money! He decides to use his gains to purchase a new wide screen television for his apartment and invite his friends over to watch the Super Bowl.

Charlotte also invests $1,000 in the same certificate of deposit. However, as opposed to Josh, after the initial year has passed she decides to re-invest her money in the same certificate of deposit. In year two of the same investment, she is now earning 7% on the $1,070 that she has accumulated. Unlike Josh, she makes a conscious decision to leave her money untouched and continue to re-invest it in certificates of deposit offering similar returns. (Many banks and credit unions will automatically rollover your certificate of deposit once it reaches maturity.)

After ten years, Charlotte’s initial $1,000 investment has turned into $1,967.15. After 20 years, it has turned into $3,869.68; after 30 years it is worth $7,612.26.

The reason for the increasing value is due to the compound interest that Charlotte has enjoyed over the course of her investment. In each subsequent year, she earns interest on the gains that she has already accumulated. Her patience has borne fruit, in the form of an extra $6,612.26 that her initial investment of $1,000 has returned.

There are additional ways that Charlotte can increase her benefits, especially if she adds regular contributions to her savings or if she finds an investment which has more frequent compounding periods. In a similar fashion, if she is able to start with a larger initial investment, her returns will be even greater.

You can experiment with the TipRanks’ compound interest calculator by plugging in different variables to better understand how different factors will impact your overall investment.

Conclusion: The Importance of Compound Interest

Compound interest is based on the idea that your money can continue to work for you. The more you can leave your money invested, the more you will enjoy its benefits.

At the end of the day, every investment represents a tension between short-term usage and long-term benefits. Exploring the way that compound interest works can help you understand this essential trade-off.

Once you fully grasp the benefits of compound interest, you will understand why it is more than just a good investment. It is the recipe for securing the long-term financial security for you and your family.

Learn money management, and use data-driven stock insights with TipRanks.


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