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How Money Grows: Understanding Interest and Compound Growth

Learn how interest helps money grow over time, exploring simple vs compound interest, savings accounts, CDs, IRAs, and the Rule of 72. Discover key financial terms and strategies for saving and investing wisely.

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How Money Grows: Understanding Interest and Compound Growth

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  1. How Does Money Grow Over Time?

  2. Interest • Interest refers to the amount you earn on the money you put to work by saving or investing. • Saving accounts, Individual Retirement Accounts (IRA), money market accounts, and Certificates of Deposit (CD) accumulation interest during the time you hold them

  3. Interest • There are two types of interest: simple and compound: • With simple interest, the money your investment earns is based solely on the principal (your initial investment amount) • Unlike simple interest, compound interest is calculated on the principle amount and interest earned to that time.

  4. Simple Interest Compound Interest However, if you put $1,000 in a CD providing an annual compound interest rate of 4%, $1,040 the first year, $1,081.60 the second year, $1,124.86 the third year, and so on • For example, if you put $1,000 in a savings account with an annual simple interest rate of 4%, • $1,040 the first year, • $1,080 the second year, $1,120 the third year • and so on

  5. The Rule of 72 • To apply this rule, divide 72 by the interest rate your investment is earning (ignore the percentage). • For example, if your investment were paying a 3% interest rate, you would double your investment in 24 years

  6. Vocabulary • 401(k) plan: A retirement savings plan funded by employee contributions and (often) matching contributions from the employer. • Diversification: Spreading investment funds through a variety of savings and investments to reduce risk.

  7. Vocabulary • Individual Retirement Account (IRA): An individual retirement account (IRA) allows a person, whether covered by an employer-sponsored pension plan, 401 (k) or not, to save money for use in retirement, deferring taxes on the account's earnings until the person begins to withdraw from the account.

  8. Vocabulary • Certificate of Deposit (CD): A special form of deposit offered by banks that generally pays compound interest for a fixed period of time. • Interest: The fee charged for using another's money or credit. It is expressed as a percentage rate over a period of time.

  9. Vocabulary • Money Market Account: A special savings account that usually pays interest rates comparable to those offered by money market mutual funds. • Savings Account: A deposit account at a bank or similar institution that earns interest.

  10. Activity • Activity Sheet 1: Saving for Retirement

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