Compound interest is interest that is earned not only on the principal amount of money, but also on the accumulated interest from previous periods. In other words, with compound interest, the interest you earn is added to the principal amount, and the interest is calculated based on the new total amount. This can lead to significant growth in savings over time.
To understand the power of compound interest, let's look at an example. Let's say you have $10,000 in a savings account that earns 5% interest per year, compounded annually. After one year, you would earn $500 in interest. However, instead of withdrawing the interest, you leave it in the account, and your new balance becomes $10,500. In the second year, you would earn 5% interest not only on the original $10,000, but also on the $500 in interest from the previous year. This means you would earn $525 in interest in the second year, bringing your total balance to $11,025. Over time, the interest earned on the interest earned can really add up.
To use compound interest to grow your savings over time, it's important to start early and be consistent with your savings habits. The longer your money is invested, the more time it has to grow. Consider opening a high-yield savings account or investing in a retirement account that offers compound interest. It's also important to avoid withdrawing the interest earned and leaving the money in the account to continue earning compound interest. By doing this, you can watch your savings grow exponentially over time.