By: Cleo Washington, Inten, Financial Literacy Writer | cleowash@umich.edu
If you were to take a scroll through Cleveland Park, you would observe its towering hardwood trees. these trees didn’t pop up overnight – rather, they are the product of seed that was planted long ago. Seeds start small and grow slowly at first; however, when they are tended to over time, they become fully developed trees. Similarly, your money grows through a process known as compound interest.
Compound interest includes the interest you earn on money you have saved, along with the interest that money has already earned. This “interest on interest” grows your money faster over time.
For example, let’s say you put $100 into a savings account, earning 5% interest per year. After the first year, you earn $5 in interest (5% of $100), leaving you with $105 at the end of the year. After two years, you earn $5.25 (5% of $105, the previous year’s ending balance), leaving your balance at $110.25. The extra $0.25 you earned for the second year is considered “interest on interest.” For year one, you earned $5 in interest on the money you previously saved, which was $100. In year two, compound interest started to take effect, as you earned $5.25 in interest, $0.25 of which was earned on the $5 you earned in interest for year one.
Albert Einstein referred to compound interest as “the eighth wonder of the world,” since it’s the key factor in increasing wealth across your lifetime.
You, too, can access this wonder, and watch your savings grow gradually. Although money doesn’t grow on trees, it does compound over time, with its interest growing each year.
So, the next time you walk through Cleveland Park, and look up at its awe-inspiring trees, remind yourself that you have the seed of compound interest, which can be harnessed to grow something even more powerful.
Author: aryanethsales
