Compound Interest: 6 Important Facts, Fiction, and Tips


Compound interest is one of the hottest topics on financial discussion boards these days. But, of course, there are plenty of reasons for that phenomenon, including the super-low interest rates being paid by mainstream banks and other financial institutions.

Consumers are turning to the stock market, eliminating high-interest debt, setting up annuities, finding higher rates in unexpected places, and doing other things to grow their savings as quickly and safely as possible.

Here are some of the most relevant facts, fiction, and tips for anyone looking to take advantage of compound interest in today’s unpredictable economy.

The Stock Market Doesn’t Pay Interest

You sometimes hear people speak about investing in the stock market as if the activity is an interest-paying investment strategy. In truth, stocks don’t pay interest. Most only appreciate or depreciate in value. Therefore, investors aim to pick companies whose shares are likely to increase in value.

Of course, many corporations pay dividends to shareholders, but dividends are not the same as interest, nor do they operate as such. So if you own dividend-paying stock, remember to reinvest those regular payouts by purchasing more shares if you want to grow your wealth. But, the fact remains, stocks are not interest-bearing financial instruments.

Deal with High-Interest Debt

Deal with High-Interest Debt

It doesn’t make much sense to seek out institutions that pay interest on savings when you’re in a financial hole. If you own high-interest credit card debt, are paying a higher-than-normal rate on a car loan, or anything else, consider eliminating the debt before going on an all-out quest to leverage the power of compound interest.

In most cases, you won’t be able to find anyone who’ll pay you a rate on your savings higher than you’re paying on plastic credit cards or vehicle loans. So, consider putting those savings goals on hold until you deal with high-interest debt. Dealing with it means paying it off in full.

Avoid “Lump Sum” Math Mistakes

Be careful not to confuse lump-sum investing and annuity strategies. In the former, you place a single “lump” of money into an interest-bearing account and let it grow for a set period of years. With annuities, you put a (usually) fixed amount of money into an interest-bearing account on a regular basis. Here’s an example of each kind of saving:

Lump-sum: You receive $20,000 in life insurance proceeds and put the entire amount into a special fund that pays six percent interest annually.

Annuity: You put $100 per month into an account that pays an annual rate of six percent interest and continue to contribute to the account for ten years.

It’s essential to know the difference between these two widespread kinds of savings techniques because the math formulas used to calculate the future value of each one are different.

The Interest Rate Is All-Important

Since the COVID pandemic hit, financial institutions have been paying historically low rates on savings and other kinds of accounts. But, there are a few ways around this sad state of affairs for long-term savers. First, assess your risk tolerance. Are you okay with investing in funds backed by stocks, cryptocurrency, and precious metals?

If so, then you have at least a moderately high risk tolerance and can probably find funds and institutions that are willing to pay higher-than-normal interest on savings. Likewise, if you can tolerate high risk, it’s possible to earn interest in excess of 15 percent annually on deposited funds.

For example, some people purchase cryptocurrency and agree to store their assets on the currency’s home platform, a process called “staking.” Many alternative currencies pay staking interest in excess of 15 percent, but you take the risk that that cryptocurrency will decrease in value at any time.

Seek Monthly Or Daily Compounding

You Don’t Need To Be Wealthy

One timeless tip for investors: the beauty of compound interest is that you need not be wealthy to take advantage of the growth effect. In other words, small and modest amounts of funds in an account that pays, for example, five percent annual interest grows just as quickly as a much larger sum. Of course, the final amounts after a fixed time period are quite different. However, even folks of modest means can leverage the incredible power of compounding.

Seek Monthly Or Daily Compounding

When you invest your money in an interest-bearing account, seek out ones that compound monthly or even daily rather than annually. In the short term, the differences aren’t so pronounced. However, in long-term funds, like IRAs and other retirement arrangements, monthly and daily compounding will deliver significantly better results than annual compounding.