It’s personal’ – What is compound interest?

SAN ANTONIO – You may have heard of compound interest investments, whether they are compounded daily, monthly, quarterly or semi-annually. But what exactly does it mean when you have compound interest?

The Consumer Financial Protection Bureau said compound interest is when you earn interest on both the money you invested and the interest you earned.

Let’s say your investment, also known as principal, is $5,000 and earns 2% interest with annual compounding for a total of 10 years. For the first year, you would have your investment of $5,000 plus the 2% you earned in interest. That’s a total of $5,100.

After the first year, compounding kicks in. Your investment will start earning interest on the interest you’ve already earned.

So in year two, your investment is now worth $5,100 and earning $102 in interest. That’s $2 earned on your first year’s $100 interest.

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Although it may not seem like much, after 10 years and due to capitalization, your investment would reach $7,429.74.

Your investment continues to accumulate year after year, giving you even more money.

But remember that most investments involve risk, so keep that in mind when deciding where to use your money.

The Securities and Exchange Commission has a tool that helps you calculate compound interest. Click here to access the SEC Compound Calculator.

“Money: It’s Personal” is a series on KSAT’s News at 9 that breaks down personal finance topics. If you have a suggestion or question about the types of topics you would like us to explain, click here.

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