This article is part of the Snackable Investing series, where I explain investment concepts in bite-sized posts. Take enough snack breaks, and you’ll digest the basics in no time!

What is compound interest (vs. simple interest)?

Compound interest is the idea that you can earn a return on two things. First, on the money that you initially invest. Second, on the money that you’ve earned from past returns. With simple interest, you only earn a return on the first part, not the second.

Confused? An example makes it clearer.

Say you invest $100 and earn a 10% return each year. After year one, you’ll have $110. In year two, you’ll have $121. See that extra dollar? That’s from the second part of compound interest, the return on the return.

Now let’s look at year three. You’ll have $133.10. Notice how your money grew even faster than it did in year two? That’s because you had even more money from past returns. The longer you invest, the more this effect builds, which is why it’s called compound interest.

Why is compound interest important?

You might think these extra dollars and cents seem small, and that’s totally valid. But given enough time, compound interest can help your money grow significantly. Based on our example, here’s what happens if you keep investing:

• 10 years: $271.79
• 20 years: $738.70
• 40 years: $5,456.82

You read that last one right. In 40 years, you’d have over $5,000. And it’s almost all from the compound part of compound interest, as you’d only have $500 if you earned a return from simple interest alone.

It’s also just from a one-time $100 investment. Imagine you invested $100 every month. In 40 years, you’d have…

$650,000. Yep, you read that right. 💰 🤑 💸

Let me clarify: This is a hypothetical example. I’m not promising you’ll make this much, especially since the 10% assumption comes with caveats.

But the example shows the power of compound interest. They say money doesn’t grow on trees, but with enough time, you might feel like it does.

Takeaways

Let’s step back and think about what compound interest means for the big picture of investing:

• Compound interest is what helps our money grow so large. It’s why we invest
• But it takes time. A long time. That’s why real investing is a slow, patient process.
• It’s also why you should be cautious of anyone who makes investing seem like a get-rich-quick scheme.

For your next snack break:

• Here’s a link to all Snackable Investing topics.
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