For the Love of... Compound Interest!?

Compound interest is one of the most important terms to fully understand for someone who is planning to invest money. It is important because it will make growing your money more effectively.

What is interest itself? It is a fee paid by someone for the right of using someone else's money. If you borrow money you pay it, and if you invest your money well you are paid for it. 

In growing your money compound interest is the interest you earn from the interest previously earned. So if you invest 100€ with a 10 % interest by the end of a year you have 110€. If you keep the money in the system the next year the principal of 100€ will again earn you 10€, but the 10€ you earned previously has also earned you and 1 extra €. This 1€ does not seem as much but as years pass it can actually make a huge difference. So basically the more time you have to let your money grow the more previous earnings will start also earning for you. The main things that help you here are the sum initially invested, how much you are able to add to this regularly, how much time you have and of course the interest you receive from your investments. 

As compound interest works it's magic ower years starting as early as possible is important. Start in your twenties if you can.  As they say, the best time to start to invest was 10 years ago; the second best time is now. So start now!

Here is a graph that shows it clearly. If you save 200€ a month and therefore invest 2400€ a year - in 20 years you will have more than 100 000€ although you have deposited less than half as much with 48 000€. You have more than doubled your money.

So what happens if you start later? If you start 10 years later by the same time you have deposited 24 000 and have earned just 11 000€. 

It is always easy to put it off, thinking that in my future I will earn more and will be able to invest more, so there is no reason to invest now when I have little money. Well, let's say you start 10 years from now and invest twice as much with 400 € a month. You will have invested the same amount of money, but the account value is just 71 000 € compared to 105 000€. So starting early with small sums is always better than waiting.

Also it is, of course, important to figure out where to invest. Saving money in a piggy bank is bad, also bank accounts have dismal interest rates (mine is at 0,3%), Savings Accounts offer up to 2% which is way better than nothing, but still dismally low. If possible strive for 7-10%.

Here is a graph that shows what happens when you invest 200 € a month for 20 years at different interest rates.

And as I stated the real magic comes in time, so the same amounts with 30 years of investing on the lower graph are really interesting visuals. As you can see the 10% interest is really taking off in an exponential manner.

So what can you do to take best advantage of compound interest?

1. Start right now!
2. Find a place which offers the best interest to you at the risk level you are comfortable with. If possible it should have automated investment option to reinvest all interest incurred. Perhaps use Mintos or Gupeer loans with buyback guarantee, which at the moment offer even 14% interest. Or a safer option would be to invest in dividend-paying ETFs, but with lower rates. 
3. Automate your deposits. Make an automated transfer to the chosen investment account or site that deposits money as soon as you receive your paycheck. So you even don't have time to miss the money you invest. Do it even weekly, even just 10€ a week is much better than nothing at all.
4. Figure out the tax system of your country and if there are any tax benefits use them. In Estonia there is an option to postpone income tax with some investments, so the 20% you would otherwise be giving to the government helps your money to grow... and you pay it when you start withdrawing money in the future. This extra 20% is very important in compounding the interest. I use this with my LHV growth account, when investing in ETFs. So figure out if there are any similar possibilities in your country.
5. From time to time look at how your investments are doing and if needed or new and better opportunities arise invest in offers giving you better interest. But make sure that you don't become too greedy. Higher interest means higher risk. Find a balance, even if it means investing a certain portion in safer options and part in higher risk and interest places. 
6. Be patient and do not withdraw the money to spend it.