If you want to save money in the long term, you can hope for the compound interest effect. This allows them to make your money work for you.
Many people dream of investing the right amount well and then being able to live off the returns. In fact, there is an opportunity to make more money just from your money through compound interest. You can even calculate the amount from which this works.
Compound interest describes how the money you invest grows over time through the continuous reinvestment of interest. The concept is based on the assumption that both the initially invested capital (the principal sum) and the interest earned on it over time generate further interest.
How exactly this works is easy to explain.
First, you invest a certain amount of money at a set interest rate. After the first interest period (e.g. one year), interest is calculated and added to the principal amount. In the next period you will then receive additional interest not only on the original amount, but also on the interest accumulated in the previous year. This means that the income from the first year also generates income in the second year.
Example: If you invest 1,000 euros at an interest rate of five percent per year, this will increase to 1,050 euros after twelve months (calculation: 1,000 x 1.05). In the second year, the interest is calculated on the entire 1,050 euros, which means you already have 1,102.50 euros (calculation: 1,050 x 1.05). In the third year the amount then increases to 1,157.63 euros (calculation: 1,102.50 x 1.05).
The mechanism behind it is quite simple: over time, compound interest leads to exponential growth of the money invested. This makes the concept a powerful tool that even small investors can use. It also represents a fundamental motivation for long-term investments, as it can allow assets to grow significantly over long periods of time.
If you want to know exactly, you can calculate even more specifically, using the so-called rule of 72.
The simple rule of thumb shows how long it takes for an investment to double at a given annual interest rate. The rule is particularly useful because it provides an approximate answer quickly and without complicated calculations.
All you have to do is divide 72 by the interest rate to get the doubling time.
For example: If you were making an investment with an interest rate of 6 percent per year, you would divide 72 by 6, which equals 12. This means that it will take approximately twelve years for your invested capital to double.
Importantly, the Rule of 72 gives a good approximation as long as interest rates are in the range of around two to twelve percent. If interest rates are very high or very low, the rule may be less precise.
The original for this article “When you can increase your wealth through smart investing” comes from futurezone.de.