Experts say the trick to growing your wealth (even if you’ve only got a small amount to start with) is by compounding interest. Famed physicist and genius Albert Einstein was quoted as saying, “Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t…pays it.” Let’s break down this concept so that you can tap into this Eighth Wonder of the World and start building your wealth!
So, what the heck does “compounding interest” even mean? According to Investopedia.com, it can be defined as, “interest that is calculated on the initial principal, which also includes all of the accumulated interest of previous periods of a deposit.” In other words, you earn interest on the interest you already earned on your initial deposit.
I’m a visual learner, so I like to use images to help me understand things. Let’s imagine a snowball at the top of a snowy hill. You pound a few handfuls of snow together and make a mini-basketball-sized snowball to start with. Think of that as your “initial investment,” the first few handfuls of money you put together for an investment. Now imagine pushing that little snowball down the hill. That’s like you taking the leap to invest it and committing not to touch it. As the snowball makes its way down the hill, it starts picking up some more snow, causing that little snowball to grow! Think of that as interest. The bigger it gets, the more surface area it has to pick up snow as it makes its way down the hill. It’s growing on itself.
As your initial deposit grows, the interest is added to the balance. Interest then gets applied to the new larger balance over and over again. It’s like making your money work for you. That’s it! That’s how compounding interest works.
A great way to start taking advantage of compound interest is by opening a savings account or CD (Certificate of Deposit) . Many credit unions let you open a CD with as little as $500. As your snowball grows over time, you’ll be able to select investment options with higher interest rates and really start letting that compound interest work in your favor.