Compounding is when you reinvest the interest you earn on an investment. Over time, this can be an effective means of accelerating the growth of your money. If you continue to reinvest your interest over a few years, you will be earning interest on your interest on your interest. The more time you give your investments, the more you are able to accelerate the income potential of your original investment, which takes the pressure off you.

How to make compound interest work for you

1. Save as much as you can for as long as you can

2. Stay invested

3. Don't spend the interest! Compound interest can be earned on both the principal and interest

The basic principles of compound interest

If you were a regular saver who was able to put away $100 a month over a long period of time, how well would you fare? Like a lot of things in life, that would depend on a number of factors, but the following basic principles hold true:

Start investing early

The more time you have, the greater the effect of compound interest. If you were to invest $200 a month from 20 to 29 years of age and then left your investment to grow, you would probably have more money at 60 years of age than someone who chose to invest that same amount per month from 30 to 59 years of age.

What difference does 1% make?

The difference between investing at 7% and 8% over time is huge, so it's important to get the best rate possible!

Growing your savings

If you saved $100 a month for 40 years and your investments compound at 6% a year, you would not have $51,360 as you might expect ($100 x 12 months x 40 years x 106%), but actually $248,552 due to compounding!

When you invest, keep in mind that compounding amplifies the growth of your working money. Just like investing maximises your earning potential, compounding maximises the earning potential of your investments. However, remember that for time and reinvesting make compounding work, so you must keep your hands off the principal and earned interest for this investment strategy to work properly.

For more information about compound interest and other types of investments available, speak to one of the financial planners at Intellichoice today on 1300 55 10 45.