The Marvel Of Compounding Interest

Regardless of the amount invested, it is better to save sooner rather than later.

Even if you are only able to put $100, $500, $1000 away into a savings vehicle and do not add another dime over the course of the account’s lifetime, put it away now.

Why? If the amount you put in doesn’t change between the two scenarios, why is it so imperative to go ahead and place that money into an account?

In addition to the simple answer that inaccessible money in savings is more likely to stay in savings than extremely accessible money in your pocket, the more compelling reason is the power of compounding and the time value of money.


When assets are placed into a savings vehicle, whether that vehicle is a traditional savings account or a more aggressive growth fund, these vehicles will earn interest.

Interest rates are in place as incentives, established by market forces, to balance borrowing and saving. These rates appear when a consumer engages in a relationship with a financial institution, when borrowing money in the form of a loan or when investing.

Higher interest rates incentivize individuals to borrow less and save more, while lower interest rates incentivize individuals to borrow more and save less aggressively.

In the context of savings, interest rates are universally incentives to save now – whether the rate is a paltry 0.02 percent or a phenomenal 4+ percent, any interest is better than no interest. However, shopping around for higher interest rates attached to savings vehicles can prove to be prudent and financially beneficial.

The Marvel Of Compounding

Be aware, however, that simple interest and compounding interest are different beasts. Simple interest is incurred based upon the principal – the original amount invested, while compounding interest is calculated based on the principal and ensuing accumulated interest.

As Albert Einstein is credited to have said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” The eminent mathematician and physicist apparently had a lot to say on the subject, as the following descriptors of “the greatest mathematical discovery of all time” and “the most powerful force in the universe” are likewise attributed to Einstein’s genius. While the accuracy of the specific quotes has long been questioned, the legitimacy of the Einsteinian sentiments is pure.

Forbes contributor Luke Landes echoes this sentiment, “Whether he said these words or something similar is relevant only to purists who say serious journalists shouldn’t attribute quotes willy-nilly to emphasize their importance. It doesn’t change the fact that compound interest should be on the mind of anyone looking to build wealth over time.”

Savings Vehicles: Not All Created Equal

Traditional savings accounts are notoriously bad growth vehicles. However, their low interest rates are attached to low risk. Stronger growth vehicles, such as growth funds, have a higher risk (but much higher reward, thanks to the higher interest rates).

When looking for a suitable savings vehicle, ask yourself the following questions:

1) What is the interest rate?

2) Is the interest rate simple or compounded?

3) If the interest rate is compounded, what is the frequency of compounding (“compounding period” length)?

4) Do the interest rates change based upon the balance? Are the interest rates dependent upon a minimum balance/Is there a minimum investment required? Is there a balance ceiling for the rate?

Regardless of how you decide to invest your assets, take the time to educate yourself about the available options, the pros and cons of all choices, and remember that you are in control of your financial health and security.

This article is part of a collaborative project between NASDAQ contributor and Benzinga Managing Editor Joe Young and Benzinga Personal Finance Writer Rebecca Sheppard.


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