What is compound interest? How does putting even a small amount of money into an account that accrues compound interest benefit your finances?

Compound interest is the interest accrued on a loan or deposit. According to David Bach, the author of The Automatic Millionaire, everyone can leverage the power of the compound interest to start building wealth. While investing a few dollars itself won’t make you a millionaire, putting those dollars in an account that pays compound interest is much better than keeping them in a checking account.

## How Compound Interest Grows Your Money

Here is how The Automatic Millionaire explained compound interest:

When you save your money in a checking account, you accumulate money for future use, but the amount doesn’t grow beyond what you put in. However, when you invest your money in an account that pays compound interest, you leverage your money—that is, you use it to generate further income in the form of interest payments. For example, if you invest your money in an account that pays you 10% annual interest, this means that you’ll receive an extra 10% of what you invested after one year: Invest \$100 and after a year, your money will be worth \$110.

Bach also notes that thanks to compound interest, the interest you earn also earns interest—the \$110 after another year will be worth \$121 (\$110 + 10%). After another year, it will be worth \$133.10. In addition, the more money you continue to add to this account, the more interest you’ll earn. This is how compound interest transforms small, consistent amounts of money into free money over the course of time.

To understand how compound interest could be earning money for you at your current income level, reexamine the unnecessary expenses you could cut out. For example, let’s assume that you’ve been spending \$1.45 each day on bottled water, which amounts to \$529.25 a year, and \$15,877.50 over the course of 30 years. So, over the course of 30 years, you could save almost \$16,000 if you eliminated this expense.

Now, if instead of simply saving your bottled water money, say you invested this money for an annual return of 10% and continued to invest \$1.45 per day (\$44 a month), your money would grow as follows:

This means that in an account that pays compound interest, the money you’re spending on bottled water could actually create over \$87,000 for you over the course of 30 years.

(Shortform note: Calculating compound interest as Bach suggests can seem daunting if you’re not mathematically-minded. Use a compound calculator to figure out how much money you could earn from the small, wasteful expenses you chose to cut earlier in this chapter.)

### Invest Early to Earn More

Bach claims that the sooner you start investing, the more compound interest will earn for you and the more likely you’ll be to achieve financial security. The following chart illustrates how much you can earn based on what age you start. It’s based on an investment of \$3,600 a year (less than \$10 a day) and an annual return of 10%.

The chart clearly illustrates the benefits of investing early—in the example above, the 25-year-old investor ended up with over \$1.5 million more than the 45-year-old investor. Further, even if your investments earn less than 10% a year, your money will still grow more than it can if it remains static in your checking account.

Compound Interest: Explained With Examples

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#### Darya Sinusoid

Darya’s love for reading started with fantasy novels (The LOTR trilogy is still her all-time-favorite). Growing up, however, she found herself transitioning to non-fiction, psychological, and self-help books. She has a degree in Psychology and a deep passion for the subject. She likes reading research-informed books that distill the workings of the human brain/mind/consciousness and thinking of ways to apply the insights to her own life. Some of her favorites include Thinking, Fast and Slow, How We Decide, and The Wisdom of the Enneagram.