Understanding Simple vs. Compound Interest

One of the fundamental money concepts is Interest.

Interest, to give a very basic example, is often a “price” that is paid to borrow money.

Simple Interest is when interest is added to the principal or the beginning amount and that interest will only be on the principal amount each year. For example a checking account.

Compound interest is when interest is added to the principal, and that interest also earns interest.

With compound interest, you earn interest on the money you save and on the interest that money earns. Over time, even a small amount saved can add up to big money. Whether you realize it or not, the concept of interest is a big part of your financial life because the possibility of earning interest is why people lend and borrow money.

What Does This Mean?

Your money can work for you when “your money earns money”. When your money goes to work, it may earn a steady paycheck. Someone pays you to use your money for a period of time. When you get your money back, you get it back plus “interest.” Your money can make an “income,” just like you. You can make more money when you and your money work, that’s how simple.