Compound Interest: How It Works And What You Should Look Out For

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As someone who seeks to increase their finances, we are sure you must have come across the term Compound Interest. This is one of the most important concepts in personal finance. After all, compound interest can cause your wealth to grow exponentially, helping you save thousands and even millions of Naira.

Compound Interest

According to Investopedia, Compounding is the process whereby interest is credited to an existing principal amount and to interest already paid. That means you are earning interest upon the interest you’ve already earned. Isn’t that amazing?

To illustrate how compounding works, suppose N10,000 is paid into an account that pays 5% interest annually. After the first year or compounding period, the total in the account has risen to N10,500. This is a simple reflection of N500 interest added to the principal. In the second year, the account will get 5% growth on both the original principal and the N500 of first-year interest, resulting in a second-year gain of N525 and a balance of N11,025. That’s how the money compounds through subsequent years.

We know compounding your finances interests you. However, we have listed three features you should consider when trying out one.

Frequency: The frequency in which interests compound on your principal matters. Daily interests of course have better results in the long run. When opening a savings account, look for accounts that compound daily.

Time: Compounding is more impressive over long periods. The longer the duration, the higher your returns. 

Deposits: Withdrawals and deposits can also affect your account balance. Letting your money grow or regularly adding new deposits to your account works best. If you withdraw your earnings, you dampen the effect of compounding.

We hope that with your knowledge of compound interests, you can be more strategic concerning your financial decisions. 

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