How to use this compound interest calculator
Experiment with your calculations both with and without a monthly contribution. This could range from $5 to $200, depending on what you can afford.
What is compound interest?
Compound interest is the interest earned on both the original amount of money and the accumulated interest. It allows savings to grow more rapidly over time.
In an account that pays compound interest, such as a standard savings account, the returns are added to the original principal at the end of every compounding period, commonly daily or monthly. Each time interest is calculated and added, the balance increases. Consequently, more interest is earned in the next compounding period.
For instance, if you deposited $10,000 into a savings account with a 4% annual yield, compounded daily, you would earn $408 in interest in the first year, $425 in the second year, an additional $442 in the third year, and so forth. After 10 years of compounding, your total interest earnings would be $4,918.
However, this is just an example. For long-term savings, there are better options than savings accounts, such as Roth or traditional IRAs and CDs.
Compounding investment returns
Investing in the stock market doesn't yield a fixed interest rate. Instead, your return is based on the change in the value of your investment. When your investment's value increases, you earn a return.
If you keep your money, including returns, invested in the market, these returns compound over time, similar to how interest compounds.
For instance, if you invested $10,000 in a mutual fund and it yielded a 6% return that year, you would gain $600, making your investment worth $10,600. If you had an average 6% return the next year, your investment would be worth $11,236.
Over time, this can significantly increase your wealth. If you kept that money in a retirement account for 30 years and earned an average 6% return, your $10,000 would grow to more than $57,000.
In reality, investment returns fluctuate from year to year and even day to day. Short-term, riskier investments like stocks or stock mutual funds may lose value. However, history shows that a diversified growth portfolio can yield an average annual return of 6%. Investment returns are usually represented as an annual rate of return.
Compounding can help achieve your long-term savings and investment goals, especially if you allow it to work over years or decades. It can result in earning significantly more than your initial investment.
Compounding with additional contributions
Compound interest can significantly boost your savings, but reaching your goals also requires regular contributions.
Revisiting the savings account example, we initially had $10,000 and accumulated $4,918 in interest after 10 years in an account with a 4% annual yield. However, if you deposit an additional $100 each month into your savings account, the total after 10 years, with daily compounding, would be $29,648. The interest earned would amount to $7,648 on total deposits of $22,000.
