Compound Interest

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We know that we pay interest to a bank for the privilege of borrowing its money, but you should be aware that they do the same for you. For money that you place in certain types of savings and checking accounts, the bank will pay you interest. One way to create savings is to let the interest paid to you compound, or build on itself. Compound interest is a very powerful tool for making your money grow, and involves earning interest on interest you have already received.

Let's say you put $1,000 in a savings account that pays 5% interest. At the end of the year, you will have received $50 in interest. Now you have $1,050. ($1,000 x 5% = $50). In the second year, you will earn 5% on $1050, or $52.50. Notice that your money grew faster. You made $50 in the first year, and $52.50 in the second. This is how compounding works. The longer the money stays in the savings account, the faster it will continue to grow, so it is a good idea to start a savings plan as soon as you can.