We’ve all heard the term “compound interest” and the math behind it, but what does it really mean? In this blog post, we will answer this question by providing 10 compound interest investments that you can start investing in today.
Compound interest is the magical formula that powers our economy. It’s also a powerful investment strategy that you can use to create passive income streams that can make your life better.
So let’s dig into this topic and learn what compounding is, how it works, and how it can impact your financial future.
What Is Compound Interest?
Compound interest is the process where the total interest on investment is calculated at the end of each year, rather than just once at the beginning of the investment.
Let’s say you invest $1,000 at 5% interest. You can calculate the compound interest for each of the years (five) by taking the interest earned from the previous year and multiplying it by the amount invested.
After five years, you’ll have $5,072.16.
Simple Interest vs. Compound Interest
There is a big difference between simple and compound interest.
One thing you won’t get from compound interest is the exponential growth it can provide.
A straight line slope is a good rule of thumb when calculating your savings rate. It's also helpful to know how much you'll have in your account at the end of a year.
If you've got compound interest, you should expect your graph to have a steep rise at the end.
If you start saving at the age of 20, you'll invest for 30 years before retiring. If you start investing at the age of 70, you'll retire in three years, because you can earn interest on your investment for three years.
The difference between simple interest and compound interest is that with simple interest, the interest earned is calculated only once, at the beginning of the investment.
For example, if you invest $1,000 at 5% interest, you would earn $50.00. At the end of the year, you would simply take the $50.00 and divide it by the original $1,000. This is the amount of interest earned for the year.
However, with compound interest, the interest earned is calculated at the end of each year, based on the amount of money you originally invested.
For example, if you invest $1,000 at 5% interest, you would earn $50.00.
Understanding Compound Interest
Compound interest refers to the principle of earning interest over time. It means that each month, a fixed amount of money is added to your account.
Imagine that you have $1,000 in your bank account. At the end of every month, the bank adds another $100 to your account.
At the end of six months, you will have earned $60,000! That's a return of 6,000%.
This is what compound interest is all about.
The concept behind compounding interest is that it builds wealth over time.
To understand how compounding interest works, let's examine a simpler example.
Let's say that you save $20 a week and put it in a savings account that earns 5% a year. In one year, you will have $2,400.
What would you say if we told you that by saving $20 a week, you could earn $6,800 in one year?
That's right. A little bit of compound interest goes a long way!
You might be wondering how compounding interest works in the stock market.
When you buy shares of stocks or bonds, you are essentially buying a piece of a company. The more shares that you buy, the larger the piece of the company that you own.
For example, you may purchase 100 shares of Apple for $1,000. If Apple's price increases to $1,500 in a year, you will have made a return of $5,000. That's a 7% return.
You have earned 7% interest on your investment!
Best Compound Interest Investments to Grow Your Money
1. Individual Stocks
Investing in individual stocks can be a risky proposition, but if you know what you're doing and take the right precautions, it can also be incredibly rewarding. Here's how it works:
An individual stock is made up of shares held by investors. When an investor buys stock in a company, he or she will receive a share of that company's earnings—this is called "dividends." The dividends will be distributed among all shareholders at regular intervals (usually quarterly). As long as the company's profits grow over time, so will its value. That means that over time, each share will be worth more than it was when it was first purchased.
The key here is that each investor owns part of the company—they don't just own shares; they actually own a percentage of the business itself! So if something goes wrong and causes the company to lose money or go bankrupt completely, then each shareholder loses some or all of his or her investment.
2. Exchanged-Traded Funds (ETFs)
Exchange-traded funds (ETFs) are an easy way to get started with compound interest investments. They're like mutual funds, but they trade on the stock market. You can buy and sell them just like any other stock, and they have their own price histories and trends.
With ETFs, you can invest in stocks without having to buy a whole company. That makes it easier to diversify your holdings across multiple companies without having to do all the work of buying individual stocks. It's also much easier to buy and sell ETFs than it is to buy and sell individual stocks—you can do it from your phone!
3. Mutual Funds
Mutual funds are like a big bank that manages your money for you. They're not banks, though. They buy stocks and bonds, collect interest and fees, and distribute the earnings to shareholders. That means you're not getting a return on the money you put in.
You can invest in mutual funds that focus on stocks, bonds, international investments or real estate. Many people use mutual funds to invest in retirement plans, 401(k) accounts and college savings plans.
Mutual funds let you buy large amounts of securities at one time. You don't need to manage your investments yourself or track how your portfolio is doing every day.
A fund manager will take care of all the details. If the investment choices don't work out, the fund manager may be able to make changes to improve the performance of the portfolio.
4. Alternative Investments
With compound interest, your money earns interest on interest. It grows faster than any other type of investment.
The main advantage of alternative investments is that you don’t have to be in the stock market to reap the rewards of stocks. Many people think investing in stocks is only about buying shares in companies.
But stocks represent ownership in a business, which produces income that is taxed as ordinary income when you receive it. The dividends you get when you buy a share of stock are taxable at the time you get them.
5. Real Estate (Direct Ownership)
Investing in real estate is one of the most popular ways to build wealth. It's also the best long-term investment.
With direct ownership, you buy a house and take out a mortgage. As the house increases in value, you can sell it for more than the original purchase price. Your profit is the difference between what you paid and what you sold it for.
In addition, you can borrow against the equity in your home and use the cash to invest in other assets. If you don't use the money to buy other investments, you can keep it. The interest you pay on the mortgage is another source of income.
6. Crowdfunded Real Estate
Real estate crowdfunding is a relatively new idea, and some people are wary of investing in real estate without an established relationship with the property owner. The real estate crowdfunding industry is growing fast, though, so there's a better chance than ever of finding a great investment opportunity.
Crowdfunding is a form of equity crowdfunding. The investor funds the project, and the person or business that runs the project raises money from other investors in exchange for a share of ownership in the project.
7. Real Estate Investment Trusts (REITs)
Real estate investment trusts (REITs) are companies that own real estate assets and manage them to generate income. REITs don't pay out a dividend to shareholders. Instead, they distribute the income from the properties they own.
A REIT can be a good investment because it provides a stable income stream. Many REITs pay dividends that grow each year. In addition, some REITs pay dividends that are guaranteed for a period of time, called a “guaranteed dividend.”
One REIT that has been paying a guaranteed dividend since its inception is the Blackstone Group REIT (BLK). The Blackstone Group REIT pays a guaranteed annual dividend of $2.15 per share.
Another REIT that pays a guaranteed annual dividend is the National Retail Properties Trust (NRPT). The NRPT has been paying a guaranteed annual dividend of $3.03 per share since its inception.
8. Fine Art
Investing in fine art can be one of the most rewarding things you can do with your money.
You'll be able to enjoy your favorite piece of art for years to come, without having to spend a dime. You'll also have a piece of art that is likely to appreciate in value over time, making it a great investment.
9. Invest in Real Estate Debt
When you borrow money to invest in real estate, the lender charges a higher interest rate. The money you put into your investment is called "interest." You earn interest on the money that you lend out, so it's important to make sure you get the best deal.
If you invest in a real estate loan that has a fixed rate, you won't earn interest on the money you lent. Instead, you'll be paying interest only until the loan's term expires. You'll then be required to start paying more interest.
On the other hand, an adjustable-rate mortgage (ARM) has a lower interest rate at first. When you're borrowing money to invest in real estate, you may be able to take advantage of an ARM. You don't have to pay any interest on the money you've borrowed until the loan's term expires. However, after the term ends, you'll be charged a higher rate.
With an ARM, you're not locked into a fixed rate; rather, the interest rate changes periodically. If the economy sours and interest rates rise, you could be hit with a much higher interest rate. To avoid this risk, you should shop around for the best loan rates available.
10. Rental Property
An investment property allows you to use the cash flow from the property to make additional investments. This strategy has a few advantages: It lets you build equity while generating more cash, and it lets you invest in real estate without needing to deal with the day-to-day operations of managing a rental property.
To find an investment property, search for homes that are currently listed for rent on sites such as Craigslist and Trulia. Look for homes in a desirable location with strong demand. Be wary of homes that require significant renovations before they're ready to rent.
If you don't have the skills or resources to fix up the home, look for an investor who specializes in making improvements. You may be able to buy a home at a discounted price and turn it into a rental property, but if you plan to live in the house, you'll have to do much of the work yourself.
Before buying an investment property, check the local housing market. If you buy in a hot area, you can expect higher rents and a bigger return. On the other hand, if you buy in a low-demand area, you may have trouble finding tenants and could lose money.
11. Stock Market
Investing in the stock market can be a great way to grow your money quickly. You invest a little bit every month, and you can see how much you earn overtime.
To grow your money faster, make sure you put your money in investments with compounding returns. These investments pay out interest to you each year, so if you deposit $100, you can expect to earn about $5 in interest.
Compounding works better than simple interest because the more you invest, the more you get. You don’t have to worry about losing any of your investment because your money is growing.
Final Thoughts
In conclusion, the compound interest formula is one of the best investments because it can grow your money exponentially. The longer you invest, the more money you will have. This is a very powerful formula for making money.
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