For this lesson, we took the Images from www.moneychimp.com/calculator/compound_interest_calculator.htm
To know how your money will grow over time, you will need to know how compound interest works.
“Compound interest is the eighth wonder of the world,” said Albert Einstein.
Compound Interest is a miracle of the financial world. It shows how your funds to grow faster and faster.
Actually, compound interest is simple: It’s the interest you get on your initial deposit and on the interest that continues to expand. Compound interest lets your savings to grow faster over time.
In an account that pays compound interest, the return is added to the initial principal at the end of every compounding interval. That’s usually daily or monthly. Every time interest is calculated and added to the account, the balance results in more profit collected than before.
When you invest in the stock market, you don’t receive a fixed interest rate. Instead, the return is based on the change in the worth of your investment. When the worth of your investment grows, you get a return.
If you put your money and the returns you earn invested in the market, the returns are compounded over time. It is done in the same way that interest is compounded.
Investment returns will change sometimes often, day to day, sometimes year to year. Speaking about the short term, investments such as stocks may truly lose value. But over a long time range, records show that a diversified growth portfolio can return an average of 6% to 7% per year. Compound interest can help you in your long-term savings and investment intentions, especially if you let it go to work over several decades.
Ok, this is the most interesting part.
We spoke about the worst scenarios on the stock market, so let see how things go on when the situation is regular.
We will show you how to calculate how your money will grow if you invest in stocks.
Let’s say you are at the beginning of your job and, yes you have your whole life to think about retirement.
This is the right moment.
If you are at the beginning of your career, your annual income is about $ 30,000.
How much can you invest in stocks?
Very little. Maybe $ 200-500. Because you have a loan for a house, a car, you have to pay off the tuition still.
Yes, but you will not invest everything in the stocks of one company. It would not be wise. You will diversify your portfolio. Because it is smart.
But let’s try to calculate how your money will grow if you invest. Say, you have zero now. But over the year you have some $5, 000 aside. That’s your savings.
And you want to invest it.
And you want to keep it for a long-term. Because short-term investing is so stressful for you, full of ups and downs and it may make you worried. We are certain you would like a peaceful life. Right?
Yes, individual stocks can go up but also can go down. But you have diversified portfolio stocks, do you remember. So, we will show you what your future will be in this example.
OK, you have that $5,000 savings and your yearly salary is $30,000 but you have the second job and you can invest in stocks $5,000 every year. And say that the interest rate is average 6%.
Because you have diversified portfolio stocks, some stocks will go up to 10% but some will go down to 2%. So let’s say that average is 6%
For the next 25 years.
See what will happen, how much money you can have after 25 years.
At the end of the period of 25 years, you will have $290,000. Not bad.
But if you invest stocks over a period of 30 or 40 years, it’s some average for retirement? That amount can be drastically bigger.
And if you increase the initial $5,000 several years later to, for example, $ 9,000, the final amount of your return is significantly higher. Here’s how it goes if you continue to invest in different stocks.
In short words, compound interest is the cash you earn on your bank balance, plus the interest that money earns. It is a process to make your money work for you. How fast your balance grows is defined by your interest rate, bank balance and the number of times your bank compounds, or pays interest, on the account.
You can take advantage of compound interest as long as you have an account that allows a return. Here’s another glance at how the balance would grow over a period of 15 years if the interest rate stayed the same.
To discover a monthly compound interest for one year or 12 months, use the formula
where “b” is the initial bank balance
and “r” is the interest rate.
A more accessible way to measure how much you can earn is to apply some compound interest calculator. You can select what your balance would be over various time frames, and factor in extra deposits to your account.
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