The Power of Compound Interest

By Claudia Mollerup-Madsen

You may often hear that it is important to start saving early, whether it be for your child’s college education or your own retirement. While it is never too late to start saving, the sooner the better, and here is why: compound interest.

How does compound interest work?

There are two kinds of interest: simple interest and compound interest. Most of us are aware of simple interest, or the interest earned on the principal of an investment.  Compound interest, on the other hand, is the interest earned on the principal, plus the interest that you have already earned. In other words, you can think of it as earning “interest on interest.”  It will help your money grow at a faster rate than simple interest. 

Anyone can benefit from compound interest. The key is to begin saving early in your career. While in your twenties, you might have student loans to pay or you might be saving for your first home. During this time period, it is still important to factor a small amount of money to contribute to a retirement account as part of your monthly budget. While you may think a small dollar amount toward savings is not worth it while you are young, it will add up to benefits down the road when you are ready to retire.

Compound interest is not only powerful for growing retirement savings, it can be beneficial to other savings as well. For example, your child’s education fund can benefit from compound interest.  Saving for your infant’s college education may seem over eager while they are still so young. However, over time, the years of compound interest will be worth the initial investment and disciplined savings.

Start saving today

Regardless of what you are saving for, it is important to start saving today. All it takes is a bit of patience and discipline. To start, identify your goals: what are you saving for? What is your time horizon? Then, build those expenses in to your monthly budget.

Every dollar you start saving today will be beneficial to your long term financial stability. Whether through your employer’s matching 401(k) program, Traditional IRA, Roth IRA, or other means of savings, today is the day to put some money away and start working to reach your financial goals.

As with all aspects of financial management, education is key. By learning about compound interest, you can position yourself to make smart investing decisions that can help you reap rewards down the road.

Claudia Mollerup-Madsen is a Vice President and Financial Advisory for Morgan Stanley.