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Investing 101: #2 Compounding Interest

Most of us will remember doing simple interest at school…If you put €100 in a bank deposit account, earning 6% interest per year, you’ll get €6 a year in interest or €60 after 10 years.

By the way, you won’t find any deposit provider in Ireland paying anywhere close to 6% now…0.6% is much more likely.
Source: 9th September 2017

‘Real world’ math isn’t quite as simple, but it could be a lot more profitable, because people tend to leave their money in the bank, so they earn interest on their interest as well as their savings. This is known as compound interest, and if we continue to use our 6% example, we can see how powerful its effect can be.

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Saving example:

Let’s take a sum of €10,000, left on deposit for 20 years.Using simple interest, 5% would give you a total of €20,000 after 20 years. Apply compound interest however, and the total jumps to €26,533. That’s an additional €6,533 or a 33% increase in value on the original investment.

chart showing compound interest performance

Warning: These figures are estimates only. They are not a reliable guide to the future performance of your investment.

Compounding can be just as powerful when it comes to investing and uses the same principle to help grow the initial investment. For compounding to work as part of an investment plan it requires two things: the reinvestment of any gains and time – which could make it one of the most powerful investment tools possible for younger investors and the strongest argument for starting as early as possible.

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Up next in the Investing 101 Series is #3 “Know yourself and invest smarter” which breaks down goal-setting, risk and different investing strategies.