What Is Compound Interest And Why Would I Care?

Back to all articles
Have you ever heard the story about Jack and the Beanstalk? It’s a classic tale of a boy who gets magic beans. He plants these beans in the ground and overnight they grow into a vine reaching up into the sky where a rich giant lives.

Well magic beans may be just a story but compound interest is real and just like magic beans, it will make your money grow and grow and grow. The catch is, it won’t make your money grow over night, but over time if you put your money somewhere it can earn interest, it will grow big! The coolest part about compound interest is that the longer you let it sit and grow, the more money you will have.

The earlier you start saving your money and putting it into an account that pays interest, like a savings account that earns interest; or in a term certificate, the less you have to save each week or month to reach your goal. For example, say you want to save up $1,200 for a super tricked out bike, you could just put your weekly allowance and all the money you earn walking dogs and get as presents into a box under your bed and if you earn $100 each month, you’d have your money in 1 year. But, if you put that $100 into a savings account that earns one half of one percent interest (0.50%), after a year you’d have $1,206. That’s a free $6 just for putting your money into a savings account!

If you put your money into a term certificate that pays you one percent interest (1%), in one year you’d have twice as much ‘free money’ – $1212.

Now, let’s say you’re willing to let your money sit and grow longer before you plan to spend it, and you keep putting away $1,200 each year, for say 10 years. In a savings account paying 0.50% interest, after 10 years you’d have $12,335. That’s $335 you earned just by putting your money in a savings account!

The real power in compound interest comes when you put your money somewhere it can earn even more interest, like in the stock market. If you invest $1,200 each year into something that earns 7% interest, after 10 years, your $12,000 would grow to $17,740.32! That’s more than $5,700 more money than you would have had if you just put your money under your bed and almost $5,500 more than you’d earn by putting your money into a savings account.

That amount gets even bigger the longer you let your money grow in the stock market. If you invest the same amount, $1,200, and are able to earn 7% interest on that money, after 20 years, you’d have $52,638! If all you did was put $1200 each year in a box under your bed, 20 years later you’d only have $24,000. That’s less than half as much money! So, it’s easy to see the power of compound interest to make your money grow, grow, grow!

The important thing to know about the stock market is that while it can help you grow your money, you can also lose your money if you invest in the wrong thing or if something unexpected happens. So, while it’s helpful, it’s not without risk, which is why it’s important to have someone who knows what they’re doing help you with your money. Savings accounts have much much less risk so they pay you less interest. In general, more risk = more interest and less risk = less interest earned.

While compound interest is a complex topic, we hope you now understand the basics and see why it’s so good to start saving your money now and letting it grow for a long, long time.

Like playing with numbers? Check out this cool compound interest calculator and see what you can save!

Youth Print and Complete budget (PDF)