Want to know just how fantastic **compound interest** is? Albert Einstein, one of the most intelligent men of the 20^{th} century, called compound interest “the greatest mathematical discovery of all time”. Compound interest, actually known as “compounding”, has been used for decades to transform savings and investments into a powerful income generating tool that requires very little effort to make it work.

At its most basic, compounding is simply the process of reinvesting the earnings that you’ve made from an asset (usually money) and generating more earnings on top of them. In order for compounding to work there are only two things necessary: 1) the reinvestment of any earnings that you make and 2) lots of time. Simply put, the longer the amount of time that your investments are being compounded, the better you will be able to increase the amount of money your original investment makes.

The best way to see exactly how compound interest works is by using a simple example. Let’s take $10,000. If you invest $10,000 at 6% interest, in a year you will have $10,600. At this point you can either take out your $600 earnings or you can leave them right where they are and collect interest on it for another year at 6%, which will then grow your investment to $11,236 by the time the second year comes to an end.

Granted, the extra amount of money that you made by leaving that initial $600 earnings only netted you an extra $36 but there was absolutely no energy expended by you whatsoever to make that money and, more importantly, it will also make more interest for you if left in your account. After year three you will actually make $74.16 and, year after year, your interest will keep earning interest and will continue to do so as long as you keep reinvesting the interest, and earnings, that you’re making.

We mentioned above that there were two things necessary for compounding to work and the second is *time*. Let’s take a look at an example of how time will affect how compound interest works for you.

If you take 2 people that are the same age, let’s say 30 years old, and one of them invests $15,000 at an interest rate of 5.5% while the other invests the same amount but *10 years later* what happens to the amount of compound interest that they make? By the time they both reached the age of 55 the person who invested *first* will have $57,200.89 in their bank account while the person who invested 10 years later will only have $33,487.15.

Basically, by giving their money 10 years more time to grow and earn compound interest, the early investor was able to make nearly *double* the amount of interest then the person who waited 10 years longer to invest, solely because of the fact that their money was compounded for an extra 10 years.

Compounding is one of the basic principles of investing but also one of the most powerful. With enough time it will, with no output of energy or effort at all on the part of the investor, grow their money substantially. In the same way that investing will maximize the amount of potential earning that you can make on your money, compound interest will maximize the potential earning of your investments. The one caveat is simply that, in order for compound interest to work, the principal amount of money that you started with and the earned interest that you make every year must never be touched but instead reinvested every single time.

Investing isn’t extremely difficult but, if you are a new investor, having a little guidance is a good idea. If you have questions about investing, how compound interest works or financial questions in general, please drop us a line or send us an email and we’ll get back to you with advice, answers and solutions to all of your inquiries.