By Chris Henry
Simply put Compound interest involves earning interest on the principal and interest from previous periods.
Let’s say you have $1,000 in an ETF’s in the US stock market.
Year 1: If the stock market returns 10% that year, your account value is now $1,100.
Year 2: If the stock market returns 10% the next year your account value is $1,210.
Year 3: If the stock market returns another 10%, your account value will be $1,331.
The amount you earn every year increases without you adding any additional money. Over time, the sum of money grows exponentially as interest is earned both on the principal (the money you put in) and the accumulated interest from all prevued periods.
There is another type of interest called Simple Interest that is much less powerful.
Suppose you invest $1,000 at an annual simple interest rate of 10% for 3 years. The simple interest earned would be $300. Therefore, the total amount at the end of the 3 years would be $1,300, less than the compounded example above.
