The Power of Compound Interest

As a teenager, buying a house or retiring can seem really far away and unimportant. In reality, it can be super beneficial to start investing early, to make those major milestones easier to achieve in the future. Compound interest is a powerful tool in investing and finance, and one of its most essential factors is the duration for which it can accumulate. In essence, the earlier you get started, the more your investment grows. 

Compounding, unlike simple interest, allows for you to earn interest on your contribution and the interest it has already generated, not just interest on the initial contribution. This allows your money to grow at a faster rate, and is super beneficial when the money is left to compound for long periods of time. The rate of compounding also varies based on the rate or return and the tax rate, so opting for a Roth IRA is a great way to help your money compound tax-free. Additionally, opting for a savings account and making regular contributions from a summer job or side hustle is a great way to get started earning compound interest as a teen.

The time value of money is an essential principle of finance, and it explains that an amount of money is worth more now than it would be in the future, because of its earning potential if invested now. Therefore, investing a sum of money as a teenager and letting it compound is more beneficial than investing that same sum of money later. The easiest way to understand the power of compounding is to look at it visually, so here is a chart. In this hypothetical situation, the annual rate of return was 10%, the initial investment was $1000, and no additional contributions were made to the account.