How to Make Money From Compound Interest

Compound interest is something you want to avoid on loans and credit cards, but it’s great if you’re getting it from one of your savings accounts.  Interest is the way that lenders make money on the cash they lend out and, when you have an account, you can use compound interest as a way to maximize the value of your savings.

Understanding Compound Interest

Normally, interest accrues on the original amount that you have in the account.  This would mean, for instance, that if you had an account that paid out 1% interest per year and made a $100 deposit and kept it in there for a year, you’d have $101 at the end of the year. 

The end of the second year, however, is where you’d start to see the compound interest kick in.  Rather than only being paid interest on the original $100, you’d be paid interest on the interest you’d already accrued, as well, and would have $102.01 in the account.  The interest builds interest, in the case of compounding.

Making Compound Interest Work for You

Using interest to make money is one of those situations where the old axiom “you need money to make money” really applies.  If you have a little bit of money in an account that pays a low interest rate, you’re not going to see much in terms of payoffs.  It takes one of three things to make compound interest work for you:

•     A long-term investment

•     A high interest rate

•     A very large deposit

How Regular People Make it Work

Most often, making money from compound interest for everyday people involves depositing a small amount of money into an account and leaving it in there for a very long time.  This is where the popularity of accounts such as IRAs comes from.  People keep money in them for many years and, by doing so with compound interest applied to the account, they end up making enough money on the investment to pay for part of their retirement.

Choosing an Account

There’s no such thing as too much interest when you’re shopping around for an account.  The higher the better.  It also makes sense to add more money to the account, if you can, so that you get a bigger payoff at the end.  Remember that every bit of money you add to the account adds to the amount you make and, when the interest is compounded, each of those small increments in the value of the account can add up to a big increase in the amount that you’ll get when you cash it out.

When you’re borrowing money, however, remember that you want just the opposite situation.  For example, if a credit card is charging you 30% interest and they apply this to your total debt, not your original debt, you end up in the exact opposite situation.  This type of interest is wonderful when it’s working for you and horrible when it’s working for one of your lenders.  To make it work for you, be patient and keep those account balances high.