Compound Interest Simply Understood

Most bank savings and money market accounts provide periodic compounding of interest, which is the interest being applied to the balance for a given period (usually monthly). What makes this such a great benefit, is that the interest applied in the current month, is applied to the balance that includes the interest from last month (and all previous months as well).

As an example, if I deposit $10,000.00 into an account earning 1.5% interest, at the end of this month the interest will be applied (added to my account) and the balance will be $10,012.50. At the end of next month, the interest will be calculated on $10,012.50 (not $10,000.00) and the new balance will be $10,025.01. This continues each month that I maintain the balance.

The best way to see the significance of compound interest is to compare savings plans with and without the benefit of compound interest.

The first chart below shows the accumulations of four weekly savings amounts: $25.00, $50.00, $100.00, and $150.00, over a period of years. There is no interest or return on investment applied to the balances.

  Without InterestWeeklySavings_NoROI

In contrast, the chart below shows the growth of the same weekly deposit amounts applying a 7% average annual return on investment.

  With InterestWeeklySavings_WithROI

Notice the upward curves of the lines, and the significant differences in the final balances compared to the first chart. The actual amounts are shown in the table below for comparison.

     Account Balance Totals

Weekly                         Balance w/o                    Balance with
Deposit                   Compound Interest        Compound Interest
$25.00                             $45,500.00                     $179,707.94
$50.00                             $91,000.00                     $359,415.88
$100.00                           $182,000.00                     $718,831.77
$150.00                           $273,000.00                  $1,078,247.65

Keep in mind that the weekly savings amounts are the same in both scenarios. The difference is the benefit we receive from compound interest. Of course we can’t benefit from compound interest if we aren’t saving, but even a small amount saved each week can grow into a sizeable amount.

Thanks for reading!

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