What is compound interest?

You might have heard the phrase, “the magic of compound interest” and wondered what exactly it means. Is it helpful or something to avoid? If you have a savings account or investment funds that accrue interest, you might know this is a helpful phenomenon because compound interest will help your money grow exponentially.

Essentially, compound interest is interest that you earn on interest. So how exactly does this work?

Compound Interest 101

Compound interest is interest earned on your initial principal amount plus any interest you’ve accumulated previously.

For example, if you have $1,000 and you earn 5% interest annually, you will have $1,050 at the end of the year. Even if you don’t add a penny to your account in the second year, you will earn 5% interest on your $1,050 total, leaving you with $1,102.50 at the end of year two.

The Formula of Compound Interest 

Another important element to know about compound interest is the compounding frequency, or how often your interest is getting added to the principal. This can vary anywhere from yearly to monthly, or even daily. Ultimately, the more often your interest compounds, the quicker your money will grow in a savings account.

To put it simply, the earlier you start taking advantage of compound interest, the more interest you will accrue. For example, if you invested $10,000, which compounded annually at 5%, it would be worth more than $40,000 after 30 years, accruing more than $30,000 in compounded interest.

The difference between simple and compound interest

If you have a savings account, it will be helpful to know if you have compound interest or simple interest. While compound interest will make your interest grow faster, simple interest is different in that it will always be calculated only on your principal amount. Therefore, the interest you receive throughout the duration of your account will always stay the same.

What is a compound interest account?

A savings account that accrues interest, such as Bellco’s Premier Money Market account, uses these factors to help multiply your money at a faster rate. In terms of compounding frequency, Bellco’s Premier Money Market account interest is compounded daily and paid monthly.

Ultimately, compound interest makes a difference. Understanding compound interest and your account’s compounding frequency will help you maximize your money’s growth potential.

Click here to learn more about savings options and to check out Bellco’s deposit account interest calculator.