Compound interest: The 8th wonder of the world
We show you the power of compound interest and how to visualize projected compound interest on your Betterment accounts.
In this article, we show you the power of compound interest and teach you how to use our tools to see how your investing accounts may grow over time.
The main idea: Compound interest is when your earnings from investments are reinvested, growing even more earnings or “compounding” over time. It’s one of the ways your savings grow.
How it works: Don’t worry, we won’t get into the complicated math. Let’s look at a scenario instead.
But first, we need to know that three things go into creating value with compound interest:
- Rate of return on your investment or savings. Usually listed as a historical annualized return for stock investing or an annual percentage yield (APY) for savings and cash accounts.
- Frequency of compounding. For stock investing, this means how often you earn dividends and for a savings or cash account, this means how often you are paid interest.
- Time period for which your money is invested. The longer this is, the more time your money has to compound.
Now let's look at a hypothetical scenario. Pretend two people each have $5,000 of savings. Over a five-year period, from August 2018 to July 2023, they each manage their money differently.
- Person 1: Keeps the $5,000 in a checking account that earns 0% interest. They still have $5,000 in July 2023 because there was no chance for their money to experience compound interest.
- Person 2: Invested $5,000 into an investing portfolio on August 1, 2018. With dividends reinvested, they averaged 7.4% annualized returns after fees, and on July 31, 2023, their account was worth $7,145.
Compounding works the same way in savings or cash accounts that pay interest. For example, our Cash Reserve account allows you to earn a variable rate APY to compound your savings. You generally pay taxes on earnings in both investing and cash accounts, but even with taxes, your money has the potential to grow over the long term due to compound interest.
Visualize compound interest on your Betterment investing account: Our mobile app and desktop platform both offer simple tools to help you see how compounding could impact your goals.
- Mobile app: Navigate to your investing account and view the Projection graph to see a visualization of how your account may compound over time.
- Desktop platform: To use the goal forecaster, navigate to your investing goal. Select the “Plan” section, then click the “Open goal forecaster” button. Our goal forecaster tool allows you to enter scenarios for deposit and target date inputs. The projection graph will show you the estimated impact of compound interest on your investment portfolio along with the chance of reaching your goal based on your inputs.