Compound Interest 101


What is compound interest?

Standard interest is calculated on the original amount invested in the account. Compound interest, however, is calculated on the original amount and any previously accrued interest. For example, let’s say you invested $3,000 into a Roth IRA account with an annual compound interest rate of 2 percent. At the end of the first year, you would have $60 in interest for a total of $3,060 in your account. If you decided not to invest any more money into that account, at the end of the second year you would have $3,121 because the 2 percent interest rate would be calculated on the $3,060 — not the original $3,000.

Is compound interest good or bad?

It depends on whether you are investing money or acquiring a loan. If you take out a loan with compound interest, you want to make sure that you pay at least the minimum amount due by your payment due date each month. If you start falling behind on loans with compound interest, it can be difficult to catch up on payments. In time, you could end up paying more in interest than the original loan amount.

However, investing money into a savings account with compound interest can be beneficial. By keeping money in a savings account, your money can grow significantly over time without having to continuously invest more.

What types of savings accounts have compound interest?

Typical savings accounts don’t have high compound interest rates because they usually have limitations on risks. Certificates, Roth IRAs, bonds, and stocks are some of the different investment options with potentially high interest rates. Those with higher risks — such as stocks — usually have higher rates. Some of these have strict rules that control when you are allowed to withdraw funds.

How do I start an account with compound interest?

The earlier you begin investing, the greater the end reward. If you are interested in learning more, contact your financial institution to discuss the different ways to invest and what each option means. Remember, you don’t need to be rich in order to start investing. Begin with what you can and invest more in the future when you are able.


Deidre Davis

Deidre Davis is the Vice President of Marketing and Communications at MSU Federal Credit Union. MSUFCU's headquarters are at 3777 West Road East Lansing, MI 48823. Contact Deidre ad or (517) 664-7877.

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