Investments with compound interest!
El beneficio del interés compuesto es que podemos multiplicar nuestro dinero con una inversión, para esto tenemos que tener en cuenta tres factores:
- The capital that we will invest.
- The time that the operation lasts.
- The interest rate.
These factors are fundamental, to achieve good results and earn money.
In compound interest, the interest we gain at the end of each period will re-invested in our initial capital, in this way capital grows at each maturity, interest is also growing since it is calculated on a higher capital that increases time after time.
For the magic of compound interest to happen , time is of the essence. We’re going to make more profits on a 20-year investment than a 10-year one, because the longer the investment lasts the greater the multiplier effect of compound interest.
In this article I will tell you different types of investments with compound interest, and so, you can see which is best suited to your needs.
Investing in mutual funds
What are mutual funds?
Mutual funds are characterized as a capital pool in which provide many investors and in which they diversify linvestments in different stocks, bonds, financial products, etc. Therefore, when we invest in an investment fund, we are several investors who are investing in several companies or assets at once.
In the investment fund we have our individual shares, but we can’t decide where to invest. The administrator of investments is who decides what assets to buy or sell, how much and when.
The advantages of investment funds are:
- You have the knowledge and experience of the professional administrator who is in charge of buying and selling the shares for the convenience of all.
- We can diversify our investment even if the amount of money is small and in addition to greater diversification we get lower risk.
- As an individual investor, it is more difficult to access certain markets and sectors, whereas with investment funds we can gain access to more markets.
- To buy a stock basket individually, we’d have more transaction costs that if we did it through an investment fund.
The disadvantages of investment funds are:
- Fund manager and specialists decide incorrectly, it is possible to obtain a negative return.
- It is important to bear in mind the overhead rates, because they could reduce the overall return on investment. There are investment funds that have no sales charges. If possible, choose one of these, but look for funds whose spending rates do not exceed 1.20%, as they would be considered to be at the highest cost extreme.
Annual interest
Another way to invest our savings with compound interest is the time-bound. While in the investment funds diversify our money, in the fixed term we bet on a single entity hoping that the interest rate and the time make the magic of compound interest happen: multiply your money.
The most important thing in this type of investments, is to choose correctly where we will invest. Then, it’s time to wait and let the Compound interest acts in our favor over time.
Let’s see how it works with an example.:
We have an initial capital of 10,000 euros with an interest rate of 5% per year for 5 years.
The interest obtained at the end of the first year will be 500 euros, increasing the capital to 10,500 euros. When we calculate the interest for the second year, it will be made over 10,500 euros, resulting in an interest of 525 euros, which will also be added to the capital, then year after year gains are increasing thanks to compound interest. It is like a snowball that is getting bigger and bigger, as interests generate new interests.
If you want to know how to calculate the compound interest, I leave you the formula below:
Compound interest formula: VF = C * ( 1 + i ) ^n
Its component:
- C= Capital
- i= Interest rate
- n= Time
- VF= Final Value
VF = 10.000 * ( 1 + 0,05 ) ^ 5 = 12.762,82 euros
These investments are more profitable when the compound interest, because there is another type of interest called simple interest, in this one interest does not accrue on initial capital therefore it will always be the same amount of interest at the end of each period throughout the operation.
Click here if you want to know the differences between simple and compound interest.
Rule of 72
There is a calculation to know how many years it would take to double our capital with compound interest.
It’s the famous rule of 72, because to get the result you have to divide the interest rate by 72.
For example, if our fund has an interest rate of 6% we will double our capital in 12 years (72/6=12), this may vary if we make new contributions to our initial capital making the timeless.