The Power Of Compounding InterestThe Power Of Compounding Interest

Compound Interest is an investor's best friend. The word compound has many different definitions, but one of those definitions is "to add to; increase". With compound interest, your money will continually increase in value. Here's an example of compound interest. Bill has $30,000.00 and invests it in a stock that has a dividend yield of 8%, and he decides to reinvest the dividends. Bill's friend Joe has $30,000.00 but is too afraid to invest in stocks, so he puts his money under his bed so he won't spend it.

After 10 years, Bill and Joe look to see how much they have. Bill has $64,767.75. When Joe looks under his mattress to see how much he has, he has $27,500(his wife found the money and decided she needed some things). Bill made his money work for him, and it did. He more than doubled the amount of money he invested in only 10 years. If Bill was to wait 15 more years, his $30,000.00 investment would be worth $205,454.25!

Here is the formula for calculating compound interest: F = P(1 + R)T. F stands for the "future value". P stands for the "principal", or beginning investment amount. R stands for the "interest rate" in decimal form. And finally T stands for the amount of time in years. If you put the numbers from the example above into the formula, you have this: 205,454.25 = 30,000(1+.08)25.

As you can see from the example, compound interest is pretty powerful stuff. Albert Eienstein said that compound interest is "the greatest mathematical discovery of all time". Two things are needed to make compound interest work to it's full advantage. The first thing is the reinvestment of earnings. In our example, Bill took the dividends he received, and bought more stock. That is an example of the reinvestment of earnings. The second thing needed is time. Time plays a very important role in compound interest. The more time you have, the better. As time goes on, your money will grow faster and faster, while you sit back, relax, and enjoy watching your money grow

by Michael Press
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Michael Press is an investor and teenage entrepreneur. He currently owns and operates PassiveIncomeInfo.com and EquityLoanAdvice.com.

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