What Is Compounding Interest and Why Should You Care?
In the world of finance, there is a term known as compounding interest. This occurs when the interest that has been generated from an investment or deposit begins to generate its own interest. In other words, the money that has been saved begins to make more money over time. This can be a powerful tool for building wealth and securing one's financial future.
But what does this mean for the average person? Why should they care about compounding interest? And how can they take advantage of it in their own lives?
To answer these questions, it is first important to understand exactly what compounding interest is and how it works. Then, we can explore why it is so important and look at some ways in which individuals can start benefiting from it. Let's get started!
What is Compounding Interest?
In simple terms, compounding interest is when the interest that has been generated from an investment or deposit begins to generate its own interest. This can happen over a period of days, months, years, or even decades.
To illustrate how compounding works, let's say you have place $5,000 in an investment that pays 8% per year. After one year, you would have $5,400 in your account. The $400 is the interest that has been generated from your original deposit.
Now, let's say you don't touch that money and leave it in the account for another year. At the end of the second year, you would have $5,832. The $400 that was generated in the first year would now be generating its own interest. In this case, that $400 earned an additional $32 This is what is known as compounding interest.
Why is Compounding Interest Important?
Compounding interest is important because it is a powerful tool for building wealth over time. When money is left to grow in an account, it can begin to generate its own interest.
Some of the other ways in which compounding interest can be beneficial include:
It can help to offset the effects of inflation. Over time, the cost of living tends to go up. This is due to inflation. Compounding interest can help offset the effects of inflation by allowing individuals to grow their money at a rate that is higher than the rate of inflation.
It can be used as a retirement strategy. Compounding interest can be a great way to grow money for retirement. By starting to save early and letting the money grow over time, individuals can end up with a large sum of money that can be used to support themselves during retirement.
It can help to reduce debt. One of the best ways to reduce debt is to make extra payments towards the debt with the highest interest rate. By doing this, individuals can save money on interest and pay off their debt more quickly.
Final Words
Compounding interest is a powerful tool that can be used to build wealth and secure one's financial future. It is important to understand how compounding works and why it is so beneficial. By taking advantage of compounding interest, individuals can start on the path to financial success. We currently offer a target return of 9% annually for our RRSP accounts, to ensure that your money doubles every 8 to 9 years!