I want interest paid on my interest
Compound interest is one of the key ways to grow savings. The term refers to when interest on savings or investments is added to the original sum – meaning that interest is then paid both on the principal and on the accrued interest.
A €1,000 principal in an account with 5% interest paid annually will earn €50 in the first year. Reinvested to get the power of compound interest, earnings grow to €52.50 in the second year, growing the savings to €1,102.50.
As time goes on, the compounding power grows. It can financially pay off to get interest paid daily or monthly (rather than annually) to maximise the returns. Beware that compounding can work in the reverse – so interest on credit cards, for example, can build rapidly if the principal owed is not paid off.
Using the power of compound interest is one of seven rules that our senior economist Ian Bright urges savers to follow to hit long-term goals. In the eZonomics video I can’t possibly save that much, Bright urges savers to not spend interest earned. “It must be ploughed back into your savings. This is critical to building wealth in the long term.”
Start saving early
The video tutorial How much money do I need to retire? gives an example of the impact compound interest can have over several decades. It urges individuals to start saving early. An important factor in meeting retirement goals is starting saving as soon as practicable.