To put it simply, compound interest is when you generate returns on both the initial capital you have invested and the earnings you have already received. It allows for to grow multifold over time and can help early savers and investors to convert small contributions into larger amounts over several years.
To give you an example, let’s say you have
AED 1,000 in a hypothetical savings account that earns five percent in annual interest. In the first year imagine you earn AED 50 as earnings, giving you a new balance of AED 1,050.
In year two, you would earn five percent on the larger balance of AED 1,050, which is AED 52.50—giving you a new balance of AED1,102.50 at the end of year two.
Do you see how compound intertest can help grow your early investments and make your money work for you over time?
Let’s understand what simple interest is – a good example is the buy-now-pay-later solution, retail installment plans, or even your car loan. In such schemes, the money you pay is deducted from the principal amount, which allows it to diminish every month.
On the other hand, compound interest is calculated on the entire amount. This is why your credit card debt can getter heavier faster if not managed quickly and efficiently.
Mutual Funds
Mutual funds offer compound interest by investing in shares of stocks that pay dividends. By reinvesting dividends of the stock to buy further shares of the same stock, you would then receive larger dividends.
Exchange-Trade Funds (ETFs)
ETFs are passively managed funds that work around the same concept of reinvesting dividends into buying more shares of stocks, allowing returns to accumulate over time and making them a powerful tool for investors looking to gradually build their wealth.
Fixed Deposit
Banks can offer fixed deposits at competitive rates, where compound interest is generated every year on a fixed interest rate.
Certificates of Deposits and Early Saver Accounts
Similarly, certificates of deposit and early saver accounts can be issued by banks with fixed interest rates and at varying tenures, which can generate increased savings over time with interest.
Retirement Accounts
These investment vehicles are purposeful and grow at a faster rate in the long term than inflation. In effect, your money works for you over your lifetime. This is how compound interest works, provided the prevailing interest rate is favourable to you.
There are several such investment products where interest is compounded. The key is to select the right investment vehicle for you, depending on your financial goals and spending power. With the support of financial advisors, banks, or even automated investment tools, you can find the right investment process to meet your needs.
The most important element though, is time. You need to give your savings account enough time to generate earnings and begin the reinvestment process. The sooner you start saving or investing, the longer you allow the money to grow.
In simple terms, there is no ‘opportune moment,’ and you can begin your journey to savings or retirement at the earliest. As Dale Carnegie said, “today is the tomorrow you worried about yesterday”. So, stop worrying and take control today
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