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If you want to grow your wealth, the best compound interest investments is one of the best ways to get there.
If you’re wondering what investments have compound interest, below are some of the best investments available today.
We’ll teach you how to calculate compound interest, what investment accounts to consider, and how growth and capital gains can impact your long-term wealth over time.
What Is Compound Interest?
Compound interest is earning interest on the interest you’ve already made. Imagine a rolling snowball.
A small snowball – representing your initial investment – gradually becomes larger as it rolls forward and adds more snow to what’s already stuck to the snowball.
The more snow (interest) the snowball (your initial investment) takes on, the bigger the snowball becomes (your final investment). That’s what compound interest can do with your savings and investments.
An Example of Compound Interest
For those of you who like to see the numbers, here’s an example of certain investments compound interest at different intervals at work:
Suppose you invest $1,000 in a five-year certificate of deposit, paying 5% and compounded annually.
The compounding will look like this:
- At the end of the first year, your CD balance will grow to $1,050. That includes your original investment of $1,000 plus $50 in interest earned.
- At the end of the second year, your CD balance will be worth $1,102.50. The amount includes $1,000 original investment, $50 in interest earned in the first year, $50 in interest earned in the second year, plus $2.50 earned on the $50 in interest you earned in the first year of the CD.
- At the end of five years, your CD will have grown to $1,276.28. From that, $26.28 is compound interest earned on your interest over the same five years.
The $26.28 in compound interest isn’t significant, but we were basing it on a modest $1000 investment and a relatively short, 5-year time frame.
The figure would be much higher if you started with a larger amount, made regular contributions, and invested for 20 or 30 years. Compound interest is the secret sauce of successful investing. One of them, at least.
What Is the “Rule of 72”?
The Rule of 72 is a simple formula used to determine the years it will take for a certain investment to double in value based on a given interest rate.
The table below illustrates how many years it will take for $1,000 to double at various interest rates (daily compounding) The Calculations are performed using the Calculator Soup Rule of 72 Calculator.)
|Actual Number of Years to Double Your Investment
|Rule of 72 Calculation
|1% divided by 72 = 72 years
|2% divided by 72 = 36 years
|3% divided by 72 = 24 years
|4% divided by 72 = 18 years
|5% divided by 72 = 14.4 years
|6% divided by 72 = 12 years
|7% divided by 72 = 10.29 years
|8% divided by 72 = 9 years
|9% divided by 72 = 8 years
|10% divided by 72 = 7.2 years
As you can see from the calculations in the table, the Rule of 72 is just an approximation, a rule of thumb. Also, the higher the interest rate, the more exact the Rule of 72 calculation becomes.
Best compound interest investments
To take advantage of the magic of compound interest, here are some of the best investments:
1. Certificates of deposit (CDs)
If you’re a beginning investor and want to take advantage of compound interest immediately with as little risk as possible, savings vehicles such as CDs and savings accounts are the way to go. CDs are instruments issued by banks that require a minimum deposit and pay you interest at regular intervals.
The money is tied up until the term of the CD reaches maturity unless you pay an early withdrawal penalty, but you will typically pay a higher interest rate than a regular savings account. CDs from online institutions and credit unions tend to pay the highest rates.
The term of a CD varies, most often ranging from three months to five years. Once the CD matures, you will have full access to your money. If you need the money sooner, you can select a shorter CD to give you more interest than if it was just sitting in a checking account.
2. High-yield savings accounts
High-yield savings accounts usually require no minimum balance (or a very low one) and pay a higher interest rate than a typical savings account.
With increasing interest rates and inflation, money in a non-interest-bearing account is lost. One of the primary advantages of high-yield savings accounts is that you accrue interest while still having the safety and FDIC insurance (up to $250,000 per account) of a traditional savings account.
Unlike most traditional savings accounts, you must maintain certain minimum balances to receive the advertised interest rate. So you must select an account within limitations you’re comfortable with.
While CDs and high-yield savings accounts typically pay more than having your money sit in a traditional savings account, they will need help keeping up with inflation. Investors need to consider more aggressive options to stay ahead of surging prices.
3. Bonds and bond funds
Bonds are usually seen as a good compounding investment. They are essentially loans one gives to a creditor, whether that’s a company or government entity. That entity or company then agrees to give a specified yield in return for the investor buying the debt.
Remember to reinvest the interest paid on a bond to compound the interest. Bond funds can achieve compound interest, too, but must be set to reinvest the interest automatically.
Bonds will have varying levels of risk. Long-term corporate bonds are riskier but offer higher yields, whereas U.S. Treasury securities are considered among the safest investments you can make, as the full faith and credit of the U.S. government back them.
Bonds can benefit an investor who wants to hold the investment long-term but can be riskier than CDs and high-yield savings accounts. That’s because the price of bonds can fluctuate during their lifetime.
As prevailing interest rates increase, existing fixed-rate bonds can decrease in price. On the other hand, if rates fall, the bond price will rise. Regardless of what happens in the interim, the band will return its face value to investors when it matures.
4. Money market accounts
Money market accounts are interest-bearing accounts similar to savings accounts. Unlike high-yield savings accounts and CDs, which also pay higher interest rates than a traditional savings account, money market accounts often allow for check writing and debit card privileges.
These allow for ease of accessing your assets while earning a little higher interest than you would in a regular savings account.
Investments that can compound your money a little faster
With today’s low-interest rates, it is generally difficult to compound with interest-only investments, but investors can also take advantage of compounding by investing in high-return investments and reinvesting the profits.
1. Dividend stocks
While long-term equities are also a good investment to compound growth, dividend stocks are even better. Dividend stocks are a one-two punch, as the underlying asset can keep increasing in value while paying out dividends, and this investment can to earn as much interest as possible compound growth if the payouts are reinvested.
If you’re looking for dividend income, you may want to look at the group of stocks known as the “Dividend Aristocrats.” This group of S&P 500 companies has increased dividends per share for at least 25 consecutive years.
Some companies on this list include Coca-Cola, Walmart, and IBM. So, for a first-time investor looking to potentially outpace inflation while compounding income long-term, dividend stocks, and dividend aristocrats are a good way to go.
Remember, these companies are more stable and less volatile, so that they may offer less potential for outsized returns than the top growth stocks.
2. Real estate investment trusts (REITs)
REITs are a great way to diversify your portfolio by investing in real estate without buying the property outright.
REITs pay out at least 90 percent of their taxable income to their shareholders in the form of dividends each year. As with other dividend stocks, investors must reinvest their payouts to enjoy the benefits of compounding over time.
REIT investors must know that these investments differ from savings accounts or CDs. REITs are sensitive to fluctuations in interest rates, which affect the real estate market disproportionately compared to other assets. And unlike very safe bank products, the price of REITs can increase significantly over time.
Less-risky compound interest investments like CDs and savings accounts will be safer options but more likely to yield a lower return.
Choices like REITs and dividend stocks can net you a higher return with reinvested dividends but will require a higher risk tolerance to ride out the ups and downs of the stock market.
The most important thing to remember is that compounding will only occur efficiently with a long time horizon.