Financial Independence 101
Compound interest is the interest earned on both the principal and the accumulated interest of an investment. This means that the interest you earn on your investment is reinvested, and then earns interest on top of the original principal amount. Over time, this compounding effect can significantly increase the value of your investment.
For example, let's say you invest $1,000 in a savings account that earns 5% interest per year. After the first year, you will have earned $50 in interest, bringing your total balance to $1,050. In the second year, you will earn 5% interest on the new balance of $1,050, which comes out to $52.50. So at the end of the second year, your total balance will be $1,102.50. If you continue to earn 5% interest and reinvest your earnings, your investment will continue to grow exponentially over time.
The power of compound interest is especially evident in long-term investments, such as retirement accounts. By starting to invest early and consistently contributing to your retirement account, you can take advantage of compound interest and watch your investments grow significantly over time.
However, it's important to note that compound interest can work against you if you have debt with high interest rates. This is because the interest on your debt will compound just like the interest on your investments, meaning that you will end up owing more and more over time. That's why it's important to pay off high-interest debt before focusing on investing for retirement.
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