Saving Accounts - The Power of Compound Interest

08 September 2011 - Which Way to Pay

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Saving Accounts - The Power of Compound Interest

If there's any magic in saving, it is the power of compound interest. When you're saving, you usually receive interest to your savings account at regular intervals. If you don't touch the interest, but let it add to your lump sum, then you start to earn interest on your interest, as well as on the original amount you saved. This is called compound interest.

The longer you leave your money, the more powerful the compound interest effect. So the earlier you start saving, the more you make from compound interest. The same applies to other investments such as shares, where you regularly reinvest dividends, or the company reinvests its profits.

There’s an easy rule you can use to work out how your savings or investments can grow with compound interest; its call the Rule of 72. If you divide the interest rate (or average annual return) into 72, the result will tell you how long it will take for your money to double without further savings.

For example, you have $10,000, which is earning 6% interest (after tax). 72 divided by 6 = 12 in other words, every 12 years your $10,000 will double. To be completely accurate, you would also need to deduct something from the interest rate if you wanted to allow for inflation.

Use the rule of 72 to remind yourself of the power of compound interest.

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