Albert Einstein was once quoted as saying, “The most powerful force in the universe is compound interest” and “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” No one is quite certain that he said these things, but consider the following:
Compound interest is the interest that is paid on both the principal and also on any interest from past years. Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount.
The more frequently interest is added to the principal, the faster the principal grows and the higher the compound interest will be. The frequency at which interest is compounded is established at the initial stages of securing the loan. Generally, interest tends to be calculated on an annual basis, although other terms may be established at the time of the loan.
The ‘Rule of 72′ states that in order to find the number of years required to double your money at a given interest rate, you divide the compound return into 72. The result is the approximate number of years that it will take for your investment to double. This formula is more or less useful for financial estimates and understanding the nature of compound interest.
For example if you want to know how long it will take to double your money at 6% interest, divide 72 by six and you get twelve years.
Want a better understanding on how compounding interest works? Check out Investopedia’s short video (under two minutes) entitled “ Understanding Compound Interest .”