The Compound Interest Effect: How Can Investors Benefit From It ?

 In order to invest your own money sensibly and profitably, it is advisable to familiarize yourself with some of the basic investment and financial terms. Interest generally plays a major role, as it is the index of how much money that has been invested in fixed-term deposit accounts or federal securities, for example, increases.

But especially when investing over a longer period of time - 24 - 60 months are common - another factor comes to the fore: compound interest. The following explains what compound interest actually is, how it comes about and how it can be used.

What Is Compound Interest?

Simple interest is, in a sense, a kind of payment or compensation for one's own financial resources that one has made available to another person or institution. Banks work with their customers' money to conduct profitable transactions, in return these customers receive a certain percentage of their deposits as compensation. Compound interest is the accrual of interest and begins after the first interest credit is posted.

A practical example: 100,000 euros are invested for 5 years, the interest rate is 5% per year. At the end of the first year, instead of the initial 100,000, there are now 105,000 euros in the account. This will not be distributed, but will now be used as a new investment calculation for the interest due.

In the second year, the new total balance of 105,000 euros will be rewarded with interest, and at the end of the second year there will be 105,150 euros in the account. This repeats itself throughout the entire term; at the end of the five years, the 100,000 has become 127,628 euros thanks to the compound interest effect

Compound Interest In Wealth Creation

Compound interest can play an important role in building wealth because money increases exponentially rather than linearly. The more money you invest and the higher the interest rate, the more the compound interest effect is. A little patience is necessary at the beginning: compound interest only begins to have its full effect after a few years, which is precisely when it is important to leave the money untouched in the account and let the interest grow.

At the beginning of every investment, you can usually determine whether interest should be paid out or added to the investment. The latter option is advisable for building wealth, as income that is immediately reinvested generates the greatest return.

Compound Interest In The Current Situation

Since interest rates are currently at a historic low, the role of compound interest on classic savings and fixed-term deposit accounts is very reduced. The gains from interest are already modest due to the investment remuneration in the per mille range, and the compound interest is correspondingly high. In the stock and real estate sectors, there are still offers with higher interest rates, and some of these offers offer a sufficient level of protection.