If you’ve ever had a savings account, you likely know that a few cents in interest every month barely adds up. The goal is “compounding returns,” which simply means that the interest you earn each month earns additional interest, which then earns even more interest. But although a savings account will help with that, you may be lucky enough to be able to afford a cup of coffee every 10 years or so at that rate. Instead, it’s important to find a way to invest your money in a high-interest account that will earn compounding returns.
What are Compounding Returns?
In financial terms, compounding generally relates to interest. The theory is that if you have $1,000 in a savings account that earns a 0.01 percent annual percentage rate, each year, you’ll earn $0.10. The next year, assuming you put no other money in it, your savings account will earn 0.01 percent interest on $1,000.10, making it $1,000.20.
Obviously, this slow interest rate growth isn’t a fast track to retiring wealthy. Instead, some opt for higher-interest options such as CDs, which can offer interest rates as high as 2.80 percent. That takes that $0.10 on $1,000 up to $28, which becomes $1056.78 in two years.
How Can Investors Receive Compounding Returns?
The most important way to ensure you get compounding returns is to choose an investment method that earns compound interest, rather than simple interest. If you’re weighing an account that offers higher interest rates with simple interest against an account that offers lower rates with compound interest, you may be better off long-term going with the compound option.
Investors take compounding returns to the next level by building an investment fund that earns even higher interest. The cumulative interest rate over an extended period of time is known as its compound return. If an initial investment of $1,000 earns 10 percent interest over five years, that will be considered its compound interest rate.
What Is the Primary Reason to Issue Stock?
The best part of compounding is that it has the power to turn your money into an income-generating machine. If done correctly, you can accelerate your earnings with minimal effort. The key is to leave the dollars you’re earning alone, rather than cashing them out and spending them.
Compounding interest goes beyond benefiting the investors. It keeps the economy healthy because consumers have their money in the national banking system. And for businesses seeking investors, compound interest encourages people to purchase shares of stock, which gives them the money they need to run daily operations and grow.
Stephanie Faris is a novelist and business writer whose work has appeared on numerous small business blogs, including Zappos, GoDaddy, 99Designs, and the Intuit Small Business Blog. She worked for the State of Tennessee for 19 years, the latter six of which were spent as a supervisor. She has written about business for entrepreneurs and marketing firms since 2011.