by Matthew Perry
(last updated February 21, 2009)
Compound interest—just the name sounds enticing. It makes me think of money and growing exponentially and—this is the best part—doing it on its own. Just imagine it: a sack of money that just gets heavier and heavier until you can't even carry it any more! Sound good? This very principal applies in real-world finances, although it may take a number of years to achieve the stunning results imagined above. Here's a quick definition of compound interest and some ways you can use it to your advantage.
Compound interest means that interest is collected not only on the principal (the money you deposit), it's also colleted on formerly paid interest. This means that if you leave your account untouched, it will collect more and more interest every year.
Think of it this way: an account with $10,000 in it that collects seven percent interest once a year will have a balance of $10,700 after one year. However, the same account with the same interest rate collected quarterly would have a balance of $10,718.59. The extra money ($18.59) may not seem like much, but with time that money adds up.
With that in mind, you can make compound interest work for you in several ways. First, when you're choosing an account, think about how often interest accrues. You'll earn more money with an account that pays interest every quarter than you will with one that only pays interest annually, and the good news is that few (if any) banks still compound as infrequently as quarterly; some do it monthly, weekly, or even daily. Be aware of how your bank works and when your account collects interest so that you can have the most money possible in your account before that time.
Finally, while you could simply leave your money to accumulate and forget about it, you'll collect more interest if you continually deposit money in your account—the larger your principal, the more interest you get.
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