When Andy Tilp, a certified financial planner at Trillium Valley Financial Planning in Sherwood, Ore., teaches high school students about financial literacy, one of his favorite exercises is to put a picture of Albert Einstein on the wall.
“I ask the class what Einstein considered the ‘most powerful force in the universe.’ Most of my students guess nuclear reactions, or some such. But the answer is ‘compound interest.’”
Why? Because the magical power of compound interest means that putting aside a little bit of cash when you are young could make you a big chunk of change in the long run.
What is Compound Interest?
With compound interest, you earn interest on the principal amount that you invest (the “principal” is the amount of money that you start with.) And you also earn interest on the interest that your investment accumulates.
That means that if you start with a principal amount of $1,000 in an account with a compounding interest rate of 8%, and you invest an additional $50 every month, after 15 years you will accumulate $19,463.44.
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The interest you earned on the original amount gets added to the baseline total—so, like “magic,” the money that your original investment earned through interest itself begins to earn interest.
The longer your money is invested the more compound interest works in your favor, making financial goals easier to attain.
You don’t have to be Einstein to see the magic in that.
Click through the slideshow to learn more about how compound interest works for you.