Since most folks should be saving for large purchases or their retirement, let’s look at some aspects of interest rates as they affect investments. An interest rate can also apply to money that’s paid to you for purchasing a bond or making some other interest-paying investment, such as a savings or money market account. In this case, the tables have turned and you’ve become the lender. You’re being paid to let someone else use your funds. Nice.
Interest on a Certificate of Deposit
A CD, or Certificate of Deposit, is issued to show that a certain amount has been deposited in a savings institution. When it matures, the depositor will receive back the principle plus interest. Interest-bearing bonds usually pay interest periodically and are issued to show that some money has been lent to an institution for a certain term. When a bond matures, the lender has the principle returned to them.
Compound Interest Vs. Simple Interest Rates
Interest can also be simple or compound. With simple interest, earnings are a percentage of the original principle – end of story. Compound interest means that earnings are added at specific intervals to the principle amount, which provides a new basis on which to figure increasingly larger future earnings – forever, or at least for the life of the loan.
Compound interest is an amazing invention, so it warrants special attention here. It’s the primary reason that you should seriously consider beginning to invest as soon as possible. Even relatively small amounts of cash can become relatively humongous amounts of cash when they are invested with compound interest over a long period of time.
Comparison of Investments with Simple vs. Compound Interest
Start with $1000 invested at 8% interest in a savings account that has simple interest and another account that has compound interest. After one year, both accounts have the same balance: $1080. But after two years, the compounding account would have $1166.40, while the account that has simple interest would have $1160. That’s whopping difference of $6.40, you say? Big deal?
It
is a big deal. After nine years, the compounding account will have $279 dollars more than the simple interest account. That’s with only $1000 invested, no new deposits, and you’ve exerted yourself only enough to do some research and to check your statements every month. It’s painless, effortless, and
the longer you let this money stay in the account, the faster it will grow.
You’ll be able to contribute increasing amounts to a compound interest account as your income grows over the years. If you consider a
traditional IRA, or some other tax-saving investment, your gains will accelerate even more. So give compound interest a second look – it will more than pay you back for your time.