How Compounding Interest Works

Compounding money or compound interest is the fastest and easiest way to make money. There are two ways to compound money and they are through investing and building a business. In your checking or savings account, you may notice that you make interest on your money. This money gets compounded, meaning that you earn interest on top of interest you have already earned. This is called compound interest and is the fastest and easiest way to make money. You can literally make money by doing nothing. These interest rates are very small, but they add up over time.

Say you have $1,000 and your bank interest rate is 1%. At the end of the year, you will have an extra $10 in our account from interest. After 10 years, you will have an extra $100 in your account from simple interest. That, however, is simple interest. Compound interest earns interest on top of the interest you have already owned. So instead of having $1,100 after 10 years, you will have $1,104.62. To see this, take $1,000 x1.01 and multiply whatever answer you get by 1.01 and do that ten times. This concept carries over to the stock market and mutual funds. Since the stock market and mutual funds generate returns far greater than 1%, compound interest can make you a lot more money.

Now first off, don’t be afraid of the stock market. When people hear of the stock market the first thing they think of is that they are going to lose all their money, but that isn’t true. The stock market has averaged about a 10% annual return every year since it has existed. It will have its ups and downs so pick a good safe mutual fund so that you are well diversified and don’t have to do your own trading. Say you invest $10,000 over a couple of years and get the average 10% return. After 10 years, with simple interest, you will have $20,000, because you will have gained an extra $1,000 every year.

With compound interest, however, you gain much more. In fact, you will have $25,937, which is an increase of $6,000 dollars from simple interest. In fact, in 10 years, you will have gained $16,000 by doing nothing. Keep dumping money in and holding the money for longer periods of time, and you will have an astronomical amount of money. This is the magic of compound interest. Building a business is another way to compound money. Did you know that if you had $100 and gained a 20% profit every week; that you will have over $1 million by the end of the year? If you don’t believe me, do the math. Take $100 x1.2 and multiply whatever answer you get 51 times. It is astonishing.

What you do is start out small and then keep reinvesting that money back into your business. Say you bought a broken bike for $100. You fixed it up and now sell it for $120. That is your 20% profit right there. Now, you take that $120 and buy another bike and fix that one up too. You sell that one for $144 and again you have a 20% profit. You keep repeating this over and over. Eventually you will have to move up into more expensive categories. Say you bought a car for $10,000 and fixed it up. Now you can sell it for $12,000 and that is your 20% profit. Re-invest that in your business and keep compounding money until you are financially secure. Compounding money is the fastest and easiest way to become financially secure. Anyone can do it through smart investing or through building a business. Do both of these at once, and you can live the life you’ve always wanted to in no time.