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How Does Compound Interest Work? - YouTube
Channel: Dan Lok
[3]
would you rather work hard for money
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or have money work hard for you compound
[9]
interest empowers you with that choice
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compound interest is a core financial
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principle
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that can drastically increase your
[16]
wealth over time but before we explore
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compound interest
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it's helpful to understand simple
[22]
interest
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simple interest is the interest you earn
[26]
on just your principal
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let's say you invest one thousand
[30]
dollars and earn five percent
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simple interest for five years in year
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one
[35]
you'll learn fifty dollars which is five
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percent of your one thousand dollar
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principal
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in year two you'll earn another fifty
[43]
dollars
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and each year thereafter you'll continue
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earning fifty dollars
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as you can see simple interest remains
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constant over time
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compound interest is a different story
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let's say you invest your one thousand
[57]
dollars
[58]
in a savings account the compounds
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annually with interest to five percent
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in year one your interest is still fifty
[67]
dollars
[67]
however assuming you keep your interest
[70]
earnings
[71]
in your account your dollar interest
[73]
will increase every year
[75]
in year 2 you'll earn 52 dollars and 50
[78]
cents
[79]
in year 3 you'll learn 55
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and 13 cents why because you're adding
[86]
your interest to your principal each
[88]
year
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so you're earning five percent on a
[90]
perpetually increasing amount of money
[93]
compared to our first example you earned
[95]
an additional 26.28 cents of interest
[99]
or 10.5 percent more over the same time
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frame this growth is known as compound
[105]
interest
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which enables you to build wealth
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without lifting a finger
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as the name implies compound interest is
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the idea of interest on
[114]
interest which occurs when you reinvest
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interest earnings
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to make more money so long as you
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continue to reinvent your interest
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your passive income will exponentially
[125]
grow
[125]
beyond calculating the growth of funds
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in a savings account
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you can also compound interest to
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estimate
[132]
the long-term growth of a stock
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portfolio let's compare the difference
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between saving money
[138]
and investing money using compound
[140]
interest
[141]
if you set aside 365 dollars per year
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the equivalent of a dollar per day and
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put it in a safe
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you'd have 365 dollars after one year
[152]
730 after two years
[155]
995 after three years
[158]
and so on if you continue this cycle for
[161]
40 years
[162]
you'll eventually save 14 and 600
[166]
while saving is important true wealth
[169]
cannot be achieved without the benefits
[171]
of compound interest
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so what if you regularly invested your
[175]
365 dollars
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in something with a higher rate of
[178]
return such as the stock market
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the historical average annual intern of
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the s
[184]
p 500 is about 10
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dating back to the 19th century if you
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annually
[190]
invested 365 into an index fund that
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tracks the s
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p 500 your investment could be worth
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three hundred ninety six dollars after
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one year
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eight hundred and thirty two dollars
[202]
after two years one thousand
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three hundred and eleven dollars after
[206]
three years
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and so on after forty years your shares
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of the index could potentially be worth
[212]
one hundred and seventy seven
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thousand seven hundred and one dollars
[216]
that's a significant increase compared
[219]
to letting your money sit idly in a safe
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as you increase your annual investments
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the future value of your portfolio
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exponentially increases although it
[228]
requires a long-term outlook
[230]
compound interest can amplify your
[232]
wealth trajectory
[233]
help you prepare for future financial
[235]
needs and improve your general lifestyle
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