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Created on 19.02.2018

The compound interest effect explained in simple terms

Compound interest only takes effect over a period of time but this makes it all the more significant. This article explains how this effect occurs.

The current market situation means that savings accounts barely generate any interest at all nowadays. Investment funds give you a better chance of higher returns. Even with small amounts, there is significant savings potential. Time does a lot of the work and compound interest ensures that the amount saved increases at a disproportionately high rate. This compound interest effect is based on the principle that the longer the term of a financial investment, the greater the compound interest effect.

An example

A 35-year-old who invests CHF 200 a month at 4% over 30 years will have pension fund assets of almost CHF 140,000 by the time he or she reaches 65. If the saving plan was started when that person was 25, he or she would receive almost CHF 100,000 more, having paid in only an additional CHF 24,000. The ten extra years of saving create extra interest of around CHF 70,000.

A longer saving period increases the gains. The shorter the saving period, the lower the compound interest effect. If a 45-year-old has only 20 years to build up his capital, with the same saving rate he will end up with only a third of the final capital of a 25-year-old. To achieve the same savings assets, the 45-year-old would have to set aside more than three times as much every month, almost CHF 650. Investors who start saving earlier can make compound interest work better for them and increase their capital more successfully.

Calculate the compound interest yourself

To find out how much interest and compound interest a particular amount with a defined term and a fixed interest rate will generate, this formula can be used:

interest-bearing capital = initial investment * (1+interest rate/100) number of years

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