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Compound Interest 101
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Student Contributor
Posted April 26, 2016
What is compound interest?
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Standard interest is calculated only on the original amount invested. Compound interest is calculated on the original amount and any previously accrued interest. In simpler terms, for example, let’s say you invested $3,000 into a Roth IRA account with an annual compound interest rate of 2%. At the end of the first year, you would have $3,060 in your account from the gained interest. If you decided not to invest any more money into that account, at the end of the second year you would have $3,121, because the 2% interest rate was calculated with the $3,060, not the original $3,000.
Is compound interest good or bad?
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Compound interest can be very good and very bad depending if you are investing money or taking out a loan. If you take out a loan with compound interest you want to make sure that you pay off that loan every month, on time. If you start getting behind on loans with compound interest, it can be extremely difficult to catch up on payments. In time, you could end up paying more in interest than the original loan amount was to begin with. However, investing money into a savings account with compound interest can be extremely beneficial, especially when you are young. By keeping money in a savings account, it allows your money to grow significantly over time without having to continuously invest more.
What kind of savings accounts have compound interest?
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Typical savings accounts don’t have high compound interest rates, because they are usually have more limitations or risk involved. Certificates of Deposit (CD’s), Roth IRA savings, bonds, and stocks, are just some of the different investing methods with potential high-interest rates. Those with higher risks (like stocks), usually have higher rates. Some of these have strict limitations that control when you are allowed to withdraw funds.
How do I start an account with compound interest?
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With compound interest, the earlier you begin investing, the greater the end reward. If you are interested in learning more, contact your financial institution to discuss the different ways to invest, and what each one means. Remember, you don’t need to be rich in order to start investing. Begin with what you can, and invest more in the future when you are able.
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