One of the key concepts to understand when it comes to investing is compound interest. This powerful financial tool can help you reach your financial goals faster and with less effort. In this article, we will explore the basics of compound interest, how it works, and how you can use it to your advantage.
What is Compound Interest?
Compound interest (CI) is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. Simply put, it is the interest you earn on your interest. This means that over time, the interest you earn compounds and grows your investment faster.
How Does Compound Interest Work?
The power of CI lies in its ability to grow your investment over time. For example, let’s say you invest N100,000 at a 5% annual interest rate. After one year, you will have earned N5,000 in interest. However, in the next year, your interest will be calculated not only on the initial N100k but also on the N5k of interest earned in the first year. This means you will earn N7,500 in interest in the second year.
So, the interest earned in the first year is compounded and contributes to the growth of your investment in the following years.
How to use compound interest to your advantage
Start as early as possible:
The key to maximizing the power of compound interest is to start investing as early as possible and be consistent with your investments. The earlier you start investing, the longer your investments have to compound and grow, leading to greater returns over time. And the longer you allow your money grow, the more it will compound and the faster your wealth will grow. You can also increase your investment over time and choose investment options with higher interest rates to maximize your returns.
Diversify
This means investing in a mix of assets such as stocks, bonds, and real estate. Diversification helps to balance your portfolio and reduce the impact of any one investment’s performance on your overall returns.
Consistency
Regular and consistent investments, even small ones, can add up over time thanks to the power of compound interest.
Choose investment options with higher interest rates
Investments with higher interest rates have the potential to grow your wealth faster due to the CI they generate. So, do your research diligently and speak with the right individuals.