Earning Interest on Interest: Unlocking the Power of Compound Interest

Earning Interest on Interest: Unlocking the Power of Compound Interest

By Ed McClure, CFP®

If you’ve spent any length of time learning about finances, you’ve likely come across the buzz about the power of compound interest, and may be wondering if this investment strategy is right for you. Well, the answer is a resounding yes! Investing money in an account with compound interest can benefit anyone, regardless of the length of time you invest. Even if you’re only investing for a short period, the earnings from compounded interest can really start to pile up.

Understanding compound interest boils down to grasping the concept of the time value of money—essentially, a dollar today holds more value than the same dollar in the future. Savvy investors leverage this principle, exercising patience to let their money do the heavy lifting and ultimately pave the way to sustainable wealth.

At McClure Wealth Management, we recognize that compound interest can spark a lot of questions. That’s why we’ve put together a handy guide to address some of your questions and help you understand how to use this powerful investment tool. 

What Is Compound Interest? 

Compound interest means that an investor will earn interest on both the initial investment and all the interest the investor gains from his or her investment. This amount can multiply at an accelerating rate and create much more money than the original amount invested. So, how does it work? 

If you take $1,000 and invest it in an account that earns compound interest at a rate of 10%, then your initial investment increases to $1,100. You then make 10% interest on $1,100, increasing the amount to $1,210. 

The compounding of interest can continue indefinitely, and eventually, you will have earned a sum far greater than the initial investment amount of $1,000. Clearly, this strategy is beneficial for all investors who want to maximize their investment and make their money work for them. 

Key Factors to Consider  

There are several key elements of compound interest that will make a difference in the amount you gain from the initial investment. A higher interest rate will create larger returns in the long run, but as tempting as the higher rate of return may be, remember that, in general, the higher the interest rate, the riskier the investment. For instance, small-cap stocks tend to produce higher returns than large-cap stocks. Though you have the potential to earn more, you also have a much greater potential to lose.  

Time and patience are absolutely critical when engaging in this investment strategy. The longer you leave your money invested, the more wealth you will generate. If you are starting late, that’s okay. Keeping money invested in an account with compounding interest in the years leading up to retirement can still yield excellent results and will be a helpful source of income in retirement. 

Another key element to consider is the frequency at which the amount is compounded. Some accounts allow for the investment to be compounded daily or monthly, while other investments compound annually. The more frequent the compounding is, the more money you will gain.  

The tax rate is another consideration. Typically, you will have to pay taxes on the interest earned, but those taxes can be delayed if the investment is made in a retirement account, such as a traditional IRA, Roth IRA 401(k), or SEP-IRA. 

Resources and Support to Help

If you’re intrigued but still have lingering questions, we’re here to help. Of course, you can access a plethora of online tools at your disposal, like the U.S. Securities and Exchange Commission Compound Interest Calculator. It factors in variables like compounding frequency, investment duration, and interest rates to estimate your potential returns over time.

However, if you crave more personalized advice on how to strategically incorporate compound interest into your investment strategy, seeking guidance from a wealth advisor could be your next savvy move. At McClure Wealth Management, we’re on a mission to empower our clients with tailored advice that aligns with their values, so they can make the most of life’s opportunities. 

Let’s chat about your goals and how compound interest can propel you forward. Give me a call at (760) 607-0611 or email [email protected] to set up a consultation.

About Ed

Ed McClure is a CERTIFIED FINANCIAL PLANNER™ practitioner and founder of McClure Wealth Management. With over 25 years of experience, Ed works with business owners who want to maximize their retirement plan benefits, businesses that need help setting up and managing a 401(k) for their employees, and families who want guidance while planning their futures. He is known for simplifying complicated and intimidating topics and making wealth management concepts easy for others to remember and understand.  

Ed has established himself as a trusted resource for business owners and individuals, and his mission is to help his clients achieve the financial independence and well-being they deserve so they can give their time and energy to the people and things they love. He has a bachelor’s degree in finance from the University of Illinois. In his spare time, Ed conducts financial workshops for the Just In Time for Foster Youth organization, which helps equip young men and women as they come out of the foster care system. He also loves to travel and spend time with his favorite people. To learn more about Ed, connect with him on LinkedIn.