One of the most common investment strategies is to use compounding interest. You see this the most with pensions, but it can be a strategy that pays off in just about any type of account or investment.
The thing is, not every trading platform, or investment is designed for a compound interest approach. That being said, you can easily hone your investments for this purpose if you know what you are looking for.
Here we look at some of the best compound interest investments that you may want to consider in your portfolio.
What is compound interest?
Let’s start at the beginning. What exactly is compound interest? In short, this basically means that it is interest building upon interest. It’s a great way to rack up the earnings, but only if you have the time to let your investment sit and grow in the process.
The process works simply by earning accrued interest as your investment holds in the market. If you have interest earnings, those should also be reinvested into the market to help accrue interest even more.
Compound interest occurs when you allow the money and the reinvestment of interest to capitalize and grow. This allows you to earn interest on your original investment, the growth of that investment, and the earnings of that investment as well.
While there are some short-term compounding strategies, it is primarily ideal for long-term growth. The real growth happens when you let those investments grow and continue to grow, while also adding back in the interest to contribute to the growth as well.
Calculating compound interest
You can calculate compound interest using a formula, the rule of 72, spreadsheets or a compound interest calculator. You may find one way easier, so we've provided all the options to help you.
Compound interest formula
Compound interest payments will vary between investment accounts and providers.
However, a formula can be applied to help you calculate compound interest: P = C (1 + r/n)nt. ‘P' is the value of your savings, ‘C' is the initial deposit, ‘r' is the annual interest rate, ‘n' is payment frequency, and ‘t' is how many years the money is invested. The total will be the compound interest you can expect to make.
The 72 rule
This is another formula, and it is more straightforward than the last one, with fewer numbers and symbols. Using the rule of 72, you can determine how long it will take to double an investment, and you divide the annual interest by 72.
For example, if the rate of return is 7%, an investment will double in approximately 10 years as 72/7=10.2.
Spreadsheet calculations
If you're savvy with spreadsheets, this may be the best approach to working out compound interest rates.
Most spreadsheet applications have a future value calculation function that you can use. The future value is the monetary value of a sum at a later date which can predict the future worth of the initial investment based on accumulated interest and interest payments.
Compound interest calculator
Don't worry if formulas aren’t your thing; plenty of online calculators can help work out compound interest. We've picked the top three that you can use to help you:
- The Calculator Site: you can switch between currencies and different types of compounding interest from simple to daily and even forex compounding.
- Monevator's Compound Interest Calculator: a user-friendly and straightforward calculator.
- Nutmeg Compound Interest Calculator: easy to use calculator that simplifies compound interest.
The Different Types of Compound Interest Investment Accounts
Before we share with you the compound interest investments we recommend, we wanted to tell you all about all the different types you can use to start saving.
- Money market accounts: you can deposit funds safely and earn interest. You can open a money market account with most banks and credit unions. Money market accounts pay higher interest rates than regular savings accounts. However, they usually require a minimum initial deposit.
- Traditional savings accounts: with a standard savings account, interest can be compounded daily, monthly or quarterly. These accounts are more relaxed, and you can usually access them whenever.
- High-yield savings accounts: a low-risk savings account that allows you to make high returns on your savings that are relatively easy to access.
- Certificates of Deposit (CDs): a savings account that holds a fixed sum of money over a fixed period ranging from six months to five years. The bank rewards you with interest on your savings for holding your money in their accounts.
- Real estate investment trusts (REITs): a company that finances income-generating real estate such as apartment buildings, hotels, warehouses and other property types. REITs generate a steady income stream for investors as they're publicly traded like stocks.
- Exchange-traded funds (ETFs): pooled investment security that tracks a particular asset. ETFs can be bought and sold on the stock market like regular stocks.
- Mutual funds: a managed fund that pools money from shareholders to invest in securities like bonds, stocks, and other assets. Mutual funds give you access to professionally managed portfolios of bonds, equities and other securities.
- Bond funds: a pooled investment vehicle that invests in bonds and other debt securities. This investment account aims to generate a monthly income with accrued interest.
- Individual stocks: you can earn compound interest by investing in stocks that allow you full or part ownership of a public company or asset.
- Dividend stocks: distribution of a company's earnings to its shareholders, and the company's board of directors determines the payout. Dividend payments are usually distributed quarterly in cash or reinvestment in additional stock.
Now that you know all about the different compound interest accounts, we've compiled a list of the six best you can choose from to help you generate compound interest and make the most of your investments.
The pros and cons
Like any investment tool, there are pros and cons involved.
Pros
✔️ Accelerate returns: depending on the investment account, you can make more short-term or long-term investments at a higher interest rate than a regular savings account
✔️ Grow investments: you may be able to turn little assets into significant investments with compound interest over time
✔️ Finance your future: if you're looking to ensure your future is well financed, you can choose an investment that lasts over 30 years which could lead to significant returns on your investment. These investment lengths are ideal if you're saving for retirement; it's never too early to start saving for your future.
Cons
❌️ Not ideal for short-term goals: although you can use some compound interest strategies short-term, they all perform best long-term, so if you're looking for quick returns, there may be better options than compound interest accounts.
❌️ Other compound interest: outside of investments, you may see compound interest added to student loans or credit card debt; this interest can increase your debt.
The 7 best compound interest investments
We’ve scoured the market to try to narrow down the options. What we share here is always subject to change in the market, but it gives you a good idea of things you can look for, or even just where to start for your compound interest investing. With any type of investment it's also worth reminding you that there are no guarantees. It's all about risk so you could increase your money but you could also come away with less.
1. Certificates of Deposit (CDs)
You may be familiar with certificates of deposit from your local bank. In fact, they likely advertise CD and savings rates to encourage people to invest in those instruments. You can find these compounding investments at just about any bank, but you can also find them in the stock market too.
Where you look for a CD to invest in is totally up to you. For example, perhaps you have accounts, or even brokerage relationships with Fidelity Investments. On their trading platform, you could search for brokered CDs. You could also talk to a rep about the options.
CDs can be both short-term and long-term.
You can receive the interest payments from them, or allow them to compound and grow. When the CD reaches maturity, you can then reinvest the entire sum plus interest into a new CD.
This savings instrument is locked into the promised rate, as long as you don’t withdraw it before it reaches maturity. Most of the time, the longer that you lock it in, the higher the interest rates will be, but that isn’t always the case.
You can choose your timeframe, or select it based on the interest rate offerings at the time you purchase the CD. Avoid withdrawing money, as this imposes a penalty and a loss of interest in the account. You need to let those funds set until that due date comes. It may be 6 months down the road, or it may be 5 years down the road.
Bank CDs are inherently risk-free, and while brokered CDs are as covered, they typically pose very little risk to invest in.
2. Money Market Account
A money market account is very similar to a savings account, but it usually has more capabilities, and might even earn higher interest. This is a savings account that has some benefits of a checking account, but there are restrictions.
In most cases, money market accounts require slightly higher balances to invest in, simply because they pay higher interest, and the nature of the account. This can create compound interest, but it really only works that way if you don’t withdraw funds from the account.
Since it is an open savings account and you can make several withdrawals a month, you have to leave it alone if you want to compound interest. That being said, even though they pay higher interest than traditional savings accounts, you can likely find better options for compound interest, unless you specifically want to have liquid funds.
The nice thing about MMAs (money market accounts) is that the funds are liquid, but still earn interest. If it scares you to tie up the money, or you suspect you might need it, this can be a good option then. But to really capitalize on the interest, you will want to let it sit as much as possible.
In most cases, banks require a minimum balance for money market accounts. This requirement is usually over £1,000 but it could be as much as £50,000 to qualify as well. The interest is higher for higher balances, and again, you need to leave it alone to capitalize on interest.
3. High Yield Savings Accounts
Another great way to compound interest is a simple savings account. But you also don’t want to settle for just any savings accounts, either. Savings accounts are notorious for yielding pretty low interest these days.
But you can find higher yielding accounts out there too.
The nice thing about a savings account is your money isn’t really tied up like it is in a CD. You have access to make withdrawals if you need to, but you have limited monthly withdrawals or you can pay a fee.
However, the limited monthly withdrawals shouldn’t be a problem if your goal is to compound interest. After all, if you’re taking money out, it really defeats the purpose of growth upon growth upon growth.
Yes, the money is liquid, but the idea is to leave it alone and let the interest build up over time. With a savings, you don’t have to reinvest interest, as it is already reinvested and compounding as soon as it is added. You also have the ability to add money as you go if you want to contribute to the growth.
Watching your bank interest rates will be important for this type of investment. Savings accounts have been dropped to pay next to nothing in some years, but have also paid really well in other years. It simply depends on the economy and the federal rates that the banks base their rates around.
If you look around carefully, and choose wisely, you might be able to find high yield savings accounts that are paying more than 3% APY. Those are the kinds of rates you really want to look for if you can.
4. Mutual Funds
Alright, let’s move away from the bank investments and look more at market investments. There are many market investments that compound interest. You just need to know what to look for.
Mutual funds might be a good place to start. A mutual fund is basically one big basket of investments. A single fund might be made up of hundreds or even thousands of stocks, ETFs, and other funds. It’s like a pool of miscellaneous investment assets combined into one.
A mutual fund is actively managed on the backend, to try to make sure the fund itself is made up of the best things to meet the goals of that particular fund. There is buying and selling happening within the fund, but you won’t see those details specifically in your account.
In your account, you hold the mutual fund, or funds, of choice and simply let the backend do their job. If they do it right, you will hopefully have earnings in your mutual fund account. Now, for compounding interest purposes, you will want to make sure that the interest and earnings are reinvested back into the funds to capitalize and compound.
You can do some research and get involved with whatever funds appeal to you, or you can use the recommended and popular funds available via your broker or platform. The nice thing about mutual funds is you don’t have to buy whole shares, so you can constantly be reinvesting or even adding to it if you want to.
You may still want to work with an account manager to help you set up your profile and diversify. If you’re just getting started, it’s ok to hold just one fund. However, as time goes by, you may want to consider holding multiple funds within your portfolio. It’s totally up to you.
5. Bonds or Bond Funds
Next up in the investment world are bonds or bond funds. Bond funds are mutual funds that are comprised of a variety of different bonds. These are typically more commonly used for earning income, but you could have them in your portfolio as a conservative compounding interest investment too.
Then, you have bonds. Again, these are often considered for interest income generation, but you can take that interest and reinvest it if you would rather.
It’s a conservative investment approach, unless you are investing in risky bonds.
Bonds operate very similarly to CDs, and if you keep the interest reinvesting in the bond, then it really does build up and accrue during the lifetime of the bond. You can find bonds with a variety of maturity dates, from as little as a few months to as high as 20 and 30 years in some cases.
Most people choose anywhere from 1-10 years for bond investments, but there are options outside of those ranges too. Bonds are based on commercial creditors and loans, basically. Companies like Sallie Mae or Goldman-Sachs take the debt of their companies and turn it into investments to help fund the loans on their end. You earn interest for the principal you give them, in return.
Bonds are considered more risky than a CD, since you are subject to the potential default of a loan. However, if you choose your bonds wisely, you likely won’t face any major issues. Price and rates of bonds are directly affected by interest rates in the market, but you can get a locked in rate.
The bond investment will need to be held until maturity, or you may lose interest or be subject to a penalty in return.
6. ETFs
ETFs, or exchange traded funds, are similar to mutual funds, but also slightly different. This investment follows a specific index, which is what dominates the value of your ETF in return. ETFs are sold on the major stock markets, and trade similarly to a stock.
ETFs are ultimately a compilation of stocks all wrapped into one fund, which is where the similarity to mutual funds comes into play. Since an ETF holds multiple stocks, it is considered less risky than just investing in stocks. However, this will heavily depend on the investment itself, and you can never fully gauge the market either.
ETFs don’t have maturity dates or anything like that. You can buy or sell them at any time. While you are invested in them, they typically bring in reliable interest income. The key to compounding interest is to take earned dividends and interest and reinvest them back into the funds.
ETFs comes in all different styles. There are many different options, including funds that focus in specific sectors. You can choose multiple ETFs to diversify as well. They generally are low-cost, because they hold multiple funds. It sometimes makes it easier to invest in some stocks of interest, because you are investing in that company without paying a high price per share, in a sense.
7. REITs
If you’re open to a higher level of risk for a possibly high return, a REIT might be a good investment for you. You can also invest in REITs or REIT funds to add a little bit of diversity to your portfolio. If they make you nervous, just make it a small percentage of your overall portfolio total.
A REIT is a real estate investment trust. These funds are solely based on real estate investments, without you having to personally buy any real estate and manage it. It dips into a pool of real estate holdings, and gives you some kickback of the income from those holdings in return.
There are many different REITs out there, but typically they pay out 90% or more of the taxable income of the holdings within the pool. This means that you as a shareholder gets some steady kickback, unless there happens to be a default or something like that within the pool.
Now, for compounding interest purposes, you will need to reinvest those dividends that you receive, or no compounding will occur. In some cases, you might actually be able to choose to do this when you make the investment. In other cases, you will have to receive the earnings and then reinvest them on your own.
These are not backed or protected investments. They can be risky in some cases.
Choose carefully if you decide to go this route, but also know there is no guarantee either.
Additional considerations
While these are the top compounding interest choices, you might find that there are other ways to invest and reinvest that appeal to you. Some of these other methods are not traditional means, but they could potentially earn interest for you.
It should also be said that many of these alternatives will not pose the same interest return, or will be riskier to invest in as well. If you're not comfortable with the risk, or you don't fully understand what might happen, it would be better to find another place for your money.
Here are a few ideas.
- Invest in physical real estate
- Fine Arts investments
- Crowdfunding investments
- Cryptocurrencies
Will you strike it rich?
If you have plenty of time for your investments to grow, it’s quite possible that they will eventually make you rich. There are many variables that will ultimately affect this, and there is no guarantee.
The problem is interest rates are unsteady. While you might find a phenomenal rate today, when you need to reinvest, rates could be terrible. It’s a toss-up, especially in the current economic environment.
To make the most of compounding interest there are some key tips to follow as you invest.
Check these out.
- Start investing early
- Reinvest any earnings
- Try not to withdraw funds for a long time if you can
- Invest according to your risk tolerance
- The best compounding comes from long-term strategies
- Do your research to choose investments, or work with a broker
And last, but not least, remember that this takes time. If you want to accumulate wealth from compounding interest, it’s not going to happen in a week, or even in a year. It takes steady reinvestment, and long-term approaches to really make the most of it.
Final thoughts
Compound interest strategies are a great way to build returns on your savings and to build your portfolio.
It takes a lot of commitment and time to make high returns with compound interest, and there are never any guarantees.
Before you jump further into the world of investments, we've got some factors you should consider to find the best compound interest investments for your needs.
Factors to consider for finding the best compound interest account:
- Principal: the amount you wish to deposit initially is essential. Some investment savings accounts require a minimum deposit and balance, so you should see which accounts you qualify for.
- Term: you need to decide how long you want to compound interest. Consider long-term investment accounts if you're in no hurry for the money back.
- Interest rates: vary between investment and savings accounts. We recommend looking for the best offers before you sign up for the first one you see. You can use one of our methods to help you work out the return on your savings.
- Compounding frequency: how many times a year interest is paid. Typically compounding occurs on a monthly, quarterly, or annual basis.
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