Investments with compound interest are the cornerstone of building wealth over time. This principle, where earned interest is reinvested to generate its own earnings, can transform small initial sums into impressive totals.
Below is a quick view of the 11 investments with the compounding effects.
| # | Investment Option | Brief Description |
|---|---|---|
| 1 | Stocks (with DRIPs) | Own a stake in a company. Reinvest dividends to acquire additional shares, leveraging compound interest. |
| 2 | Mutual Funds | Pool money for a diversified mix of assets. Reinvestment leads to compound growth. |
| 3 | Retirement Accounts (401(k)s, IRAs) | Offer tax benefits amplifying compound interest. Reinvested profits grow at a compounded rate. |
| 4 | REITs | Own/finance income-producing real estate. Reinvest dividends for compound growth. |
| 5 | Robo-Advisors & Investment Platforms | Tech-based tools automate reinvestment, maximizing compound interest benefits. |
| 6 | DRIPs | Corporations allow shareholders to reinvest dividends to buy additional shares, harnessing compound interest. |
| 7 | Savings Accounts | Deposit money to earn interest, which is compounded over time. Known for safety and simplicity. |
| 8 | Money Market Accounts | Combine features of savings and checking accounts with better interest rates. Offer compound interest benefits. |
| 9 | Certificates of Deposit (CDs) | Commit money for a set time with banks/credit unions in exchange for higher interest rates. Interest is compounded based on set intervals. |
| 10 | Compound Interest Bonds | Lend money and let the interest accumulate until maturity. Interest compounds on the original amount. |
| 11 | Compound Interest Loans (Lender’s perspective) | Lend money and earn interest on both the principal and accumulated interest. Can be lucrative, but caution is advised due to ethical considerations and potential borrower defaults. |
1. Stocks (especially with Dividend Reinvestment Plans)
Stocks offer a stake in a company’s ownership. When these companies turn a profit, they might distribute dividends to their shareholders. By opting for Dividend Reinvestment Plans (DRIPs), investors can automatically reinvest these dividends to acquire additional shares.
Over time, as these additional shares also yield dividends, the magic of compound interest becomes evident, leading to exponential growth in the investor’s holdings.
2. Mutual Funds
Mutual funds pool money from numerous investors to purchase a diversified mix of assets like stocks, bonds, or real estate.
As these underlying assets produce returns, the mutual fund can reinvest these earnings. This leads to the acquisition of more units or shares of the fund, which in turn can earn further returns, illustrating a cycle of compound growth.
If you would like to explore this investment type, check this detailed guide “5 Steps to Invest in Mutual Fund” from NerdWallet.
3. Retirement Accounts (like 401(k)s and IRAs)
Retirement accounts offer tax benefits that can amplify the effects of compound interest. Within these accounts, profits from investments (stocks, bonds, mutual funds) are often reinvested without immediate tax implications. This deferral allows the investments to grow at a compounded rate, untouched by taxes until withdrawal.
4. Real Estate Investment Trusts (REITs)
REITs, one of the pivotal investments with compound interest, specialize in owning or financing income-producing real estate across diverse sectors such as retail spaces, office buildings, or apartments. A defining characteristic of REITs is their mandate to distribute a majority of their taxable income as dividends.
By reinvesting these dividends, investors not only tap into the essence of compound interest but also witness compound growth. As they accumulate more shares, they position themselves to earn dividends on an even larger scale in subsequent periods.
5. Robo-Advisors & Investment Platforms
With the rise of technology in finance, robo-advisors and online platforms have emerged as popular avenues for harnessing financial growth mechanisms. These platforms often automate the reinvestment of dividends and capital gains, ensuring that users continually benefit from investments with compound interest, amplifying their wealth-building potential over time.
Moreover, as these tech-based tools keep improving, they make investments with compound interest simpler for everyone. Think of them as smart helpers: they take your money, spread it across different places to earn more, and put the earnings right back to work. This loop helps your money grow faster.
So, with these online tools, not only do you save time, but your money works harder for you, thanks to the wonders of compound interest.
6. DRIPs (Dividend Reinvestment Plans)
Many corporations offer DRIPs as part of their wealth accumulation strategies for shareholders. Instead of receiving dividends in cash, participants in a DRIP can automatically use those dividends to buy additional shares, often without any commission fees. This not only allows shareholders to grow their holdings without out-of-pocket expenses but also ensures that dividends from these new shares contribute to further growth.
Over time, this cycle of reinvesting dividends amplifies the power of compound interest, turning seemingly small dividends into significant assets. For long-term investors, DRIPs can be a strategic tool to maximize returns and harness the full potential of their investments.
7. Savings Accounts
Savings accounts are one of the most familiar forms of investments with compound interest for many people.
They work like this: you put your money in, and the bank gives you a little extra as a ‘thank you’ called interest. What’s cool is that over time, you not only get interest on the money you deposited but also on the interest you’ve already earned. This is the compound interest magic.
Even though the extra money you get (interest rate) might be small compared to other investments, the beauty of savings accounts is their safety and simplicity. Plus, with regular deposits and time, that steady growth can add up!
8. Money Market Accounts
Think of money market accounts as the older sibling to regular savings accounts. They’re a type of investment that mixes the best of both worlds: the safety and easy access of a savings account with some perks of a checking account. Because they’re a bit special, they often come with better interest rates. This means your money grows a tad faster.
Every day or month, the interest you earn gets added to your total, and then that new total earns even more interest. This cycle, known as compound interest, makes your savings balloon over time. So, if you’re looking for an investment that offers a bit more punch than a basic savings account but still provides comfort and accessibility, a money market account could be a smart choice.
9. Certificates of Deposit (CDs)
CDs are a classic choice among investments with compound interest. Offered by banks and credit unions, these are like promises: you agree to leave your money untouched for a set time, and in return, they offer you interest rates that are usually higher than what you’d get with regular savings accounts.
The real magic happens with how often they add the interest to your total. Whether it’s daily, monthly, or yearly, this compounding process lets your interest earn its own interest. Since you’ve committed to keeping your money in the CD for a specific period, it gives compound interest an uninterrupted chance to boost your savings significantly.
Read More About: The Common Compound Interest Frequencies.
10. Compound Interest Bonds
Imagine lending someone money and, instead of getting small payments back now and then, you let the interest grow and grow until the very end. That’s the idea behind compound interest bonds, a popular investment for those wanting to harness the power of compounding.
Unlike regular bonds that give you interest payments periodically, these bonds keep stacking the interest onto the original amount. This means the interest you earn starts earning its own interest. By the time the bond reaches its maturity date (the agreed-upon end date), you get back your original money plus all the accumulated interest.
For those seeking investments that capitalize on compound growth, these bonds can be a straightforward and effective choice. They offer a clear picture: you know when you’ll get your payout and can anticipate a chunky return thanks to the wonders of compounded interest.
11. Compound Interest Loans (from the lender’s perspective)
In the realm of investments with compound interest, compound interest loans present a unique proposition for lenders and creditors. At its core, compound interest works by accumulating interest on both the principal amount (the original loan) and any previously earned interest. For lenders, this can be a significant advantage.
While many loans, such as simple interest loans, only accumulate interest on the principal, compound interest loans take it a step further. Interest is added to the outstanding balance at set intervals, which could be daily, monthly, or annually. This means the next time interest is calculated, it’s done on this new, larger balance. Over time, especially if the borrower isn’t making sufficient payments, the amount owed can balloon rapidly.
However, it’s crucial to tread with caution. While compound interest loans can be lucrative investments with compound interest for lenders, they can also be particularly burdensome for borrowers, especially in the case of predatory lending practices. Ethical considerations aside, lenders should also be mindful of potential defaults if borrowers find themselves unable to manage their escalating debt.
Conclusion
Investments with compound interest can act as catalysts for wealth creation. By understanding and leveraging these avenues, investors can set themselves on a trajectory towards significant financial growth.
Always remember to align your investments with your risk tolerance and financial goals, and consider consulting a financial advisor for personalized advice.
If you would like to see a simulation of how your investment can grow over time, use our compound interest calculator.
