Are you searching for the best compound interest investments?
You're in the right place!
You likely already know the benefits that compound interest can provide, but you might not know which types of accounts can help you maximize your earnings.
In this post, I'll explore some of the best compound interest investments to grow your money and invest wisely. Let's get started!
What is Compound Interest?
Before going into the details of which compound interest investments are better than others, you must first understand what exactly compound interest is.
According to Investopedia, compound interest is “the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods.”
A great compound interest example is a savings account. Each month you are paid a small amount of interest on your money. The second month, not only will you make compound interest on your initial investment, but your interest will also generate interest.
Another compound interest example would be the stock market. Each year, traditional stock investments like an index fund will increase in value by around 7%. The second year, your additional 7% will also increase by 7%.
There are many investment options you can use to increase your compound interest earnings that I’ll cover below.
Related: How to Invest and Make Money Fast
What is Compound Interest Investing?
Compound interest investing is the process of investing in assets that routinely pay you and grow exponentially.
Investing your money in things like an index fund, mutual fund, or treasury securities are all examples of compound interest investing.
How to Manage Your Investment Portfolio for Good Returns
When it comes to managing your investments, it’s all about risk verse reward. For investments with lower risk, you’re likely to see smaller returns. As an investor, your goal is to find investments that maximize your returns while limiting risk.
The best way to limit risk is through diversification.
In simplest terms, this means not putting all of your eggs in one basket.
When investing, this means using a variety of investments in the case that one specific investment fails, your others will be there to prop up your entire portfolio.
By combining safe and volatile investments, you’ll get the best of both worlds.
A well-diversified portfolio will feature a variety of asset classes and investment choices that I’ll explore below.
Top Compound Interest Investments to Grow Your Money
Using compound interest to grow your money is a no brainer. As you earn interest you will make more money that can be reinvested. Below are some of my favorite compound interest investments you can use.
Investing in the stock market is one of the most reliable compound interest investments.
Investing in the stock market can be done through various methods. While the market consists mainly of individual stocks, it also offers other investments like mutual funds, index funds, and ETFs – which are a collection of individual stocks. Below I'll explore some of the best stock market investing options.
There are several types of index funds that can generate compound interest. These include:
- Total market index funds
- Broad market index funds
- Industry sector index funds
Index funds are known for their low fees and fantastic diversification. This means that they are a reliable compound interest investment that can bring return for many years to come.
An index fund can be a good investment for beginners just looking to get started with the power of compound interest.
For many index funds and stock investments, you can assume a 7% annual return on investment that compounds each year.
ETFs feature some of the lowest management fees investors can get but they come with a few other benefits.
This investment is similar to index funds in that they are extremely diversified which limits risk. Another great benefit is the lower initial investment. While some index funds can cost thousands of dollars to invest in – most ETFs will cost less than a few hundred dollars. Even better – many online brokerages will allow you to purchase fractional shares to lower the cost even further.
Another stock investing option includes mutual funds. These are extremely similar to index funds and ETFs but they typically have somewhat higher fees. They can also contain other assets such as real estate.
A mutual fund is a great way to build your compound interest investments.
When picking individual stocks, you might consider investing in dividend stocks to grow your compound interest.
Dividend stocks are different than other stocks in that they tend to be more mature and are often less sexy when compared to growth stocks.
When a company has reached it's peak and its growth slows, many companies will begin to distribute the companies profits to shareholders in the form of a dividend.
Dividends can be paid regularly to shareholders depending on how the company performs. Most commonly dividends are paid quarterly but there are some stocks that pay dividends monthly or annually.
Dividend stocks can be an excellent compound interest investment if you structure your portfolio correctly. When purchasing a stock you can choose to reinvest dividends. This means that whenever a company pays you a dividend, that money goes toward purchasing more stock at equal value to your dividend payment.
If you aren't sure which dividend stocks to pick, you could choose to invest in a dividend ETF to stay diversified.
A publicly traded stock that is still in the earlier phases of its life is known as a growth stock. These investments have a strong outlook for years to come.
Unlike dividend stocks, these investments often do not pay dividends to shareholders because they would rather use the capital to further grow the business.
Related: Investments That Pay You Every Month
Real Estate Investing
Similar to investing in stocks, investing in real estate comes with many options to grow your wealth. Real estate is a great way to diversify your investment portfolio and hedge against inflation.
Purchasing a rental property is one common method to investing in real estate. This method will require the most capital and work to get started but it is also one of the more profitable methods.
When you start investing in rental properties, you’ll want to be sure you have the capital and skills to create the value you’re searching for.
You’ll need to analyze how much capital you have to invest, research where you want to purchase your property, and understand the rental rates in the area for a property of similar value.
When you own properties you can choose to hire a property management company to help you keep up with maintenance and other requests.
Rental properties come in all shapes and sizes. You can opt for a residential property like a single family home or duplex, or you may consider commercial real estate to build wealth. Either way, real estate investments can be a great method to compound your money.
Real estate investment trusts are a simpler option to get started in the world of real estate investing.
In short, real estate investment trusts act similar to stocks. Instead of having to manage property, collect rent, etc, this is all completed for you.
When you invest in a REIT, you’ll receive a portion of the profits similar to a dividend stock. REITs are lower risk investments that can be a great way to further diversify your investment portfolio.
A high interest savings account is a great way to grow your compound interest each month. And because a savings account is very low risk, it's also extremely safe.
There are many online savings accounts that you can use to generate compound interest.
A high yield savings account will often pay around 10 times what standard savings accounts will offer, so why not register?
You can easily connect your savings account to your bank account to transfer money to and from both accounts.
While the accrued interest you'll make from a savings account isn't the largest, it's a safe option to grow your money.
Bonds are a simple way to generate compound interest with low risk.
There are several types of bonds you might consider including treasury bonds, municipal bonds, or corporate bonds.
Government bonds are considered the safest but also have the lowest interest rates. Municipal bonds are also on the safer side but have low yields.
Corporate bonds will offer a higher interest rate but also have the most risk.
For diversification purposes, I suggest a variety of government bonds and corporate bonds. Just like an index fund, you can also invest in a bond fund to build your passive income and generate compound interest.
Money Market Accounts
Just like a high yield savings account, a money market account has an annual interest rate much greater than a traditional savings account.
Money market accounts are perfect for those with a small risk tolerance because of how safe they are.
Certificates of Deposit
CDs are a rather safe investment that are similar to both money market accounts and savings accounts. With this investment option your money will be deposited into your account and grow exponentially.
There is one main downside to CDs, however. In most cases, your money cannot be withdrawn penalty free before the maturity date.
Related: Types of Income
Investing in a Business
While this compound interest investment often gets overlooked, it has some serious potential. Starting a business can be a great way to grow your wealth and earn extra money each month.
When you invest money in a business, your returns can be extraordinary. While you won't receive a direct interest payment that you would from say, a savings account – you'll instead build equity in your business that can be worth much more over time.
How Can You Invest in a Small Business?
My favorite way to invest in small business is by starting your own. This gives you the most control of your venture and allows you to make smart decisions to grow your company.
If you don't want to start a new business, you might consider purchasing an existing business to grow your money. This comes with a few additional challenges.
If you're purchasing a business that has strong cashflow, you'll pay a premium for the work the current owner has done. But this business will have less risk because it is already established.
Related: 31 Profitable Business Ideas
Types of Businesses To Invest In
My favorite types of business to generate compound interest are rental businesses or small service businesses.
With a rental business, you’ll generate passive income each time you rent out your property.
With a service business, you can get started for cheap. For example, a starting a painting business can cost less than a few thousand dollars and provide great returns on your money.
How Much Money Can Compound Interest Make?
Depending on your initial investment, you can generate thousands of dollars each month in compound interest.
Compounding interest takes time. The longer you let your money grow, the more money you will generate.
Take a look at this chart to see the true power of compound interest. You’ll notice that the increase is small at first, but accelerates exponentially in later years. The accumulated interest in the later years is worth the entire portfolio at the beginning.
Depending on your financial goals, it’s possible to make millions annually in compound interest alone.
But remember, past performance is no guarantee of future results. You should only invest what you can afford to lose.
Need more help?
Let's take an example to help you better understand how compound interest can help you get rich.
Let's say you invest $10,000 into a a well-diversified index fund. Assuming a 7% annual interest rate, after the first year, your account would be worth $10,700. Not bad!
But where the magic really happens is after the first few years.
After the second year, your account value would be $11,449. Remember – you only invested $10k meaning you've made $1,449 in interest alone.
After the third year, your account would be valued at $12,250. You’ve now generated $2,250 in compound interest.
Why You Need Compound Interest Investments
Some personal finance experts harp on the benefits of compound interest. And for good reason. It's a great way to build wealth and make money doing nothing.
Reach Financial Freedom
If you're on a journey to financial freedom – compound interest investments will be critical to reaching your goals.
Making routine monthly contributions to your investing accounts will be essential to build wealth.
Because your investments will fuel your future life, investing in compound interest assets is vital to your success.
To reach financial independence, you should assume a 4% withdrawal rate each year from your investments to live off of.
Save for Retirement
Another reason you need compound interest is for your retirement savings.
Each time you deposit money into a retirement account your future self will thank you.
Between an individual retirement account and a 401k – you have a few options to for your retirement savings to grow your money.
Build Passive Income
Maybe your financial goals aren't necessarily to retire early or save for your retirement, but you just want to make more money.
The interest you can make from your investments can be enough to buy a new car, perform a home upgrade, or something else.
Related: Top Passive Income Apps
Accounts that Pay Compound Interest
Not all of the methods listed above pay strict compound interest. For some of them, the gains are made through increase in value. Below are some of the best compound interest investments that pay interest.
- High yield savings account
- Money market accounts
- Certificate of Deposits
How Old Do You Have to Be to Invest in Compound Interest Accounts?
In general, you'll need to be 18 years old to open bank accounts without the help of a parent or legal guardian.
Some banks will allow you to open a bank account before 18 with the consent of your parent or legal guardian.
Considerations Before Investing
Generating compound interest can sound like a dream for many, and for most it can be. But there are some things to keep in mind before investing all of your cash into assets.
Because the economy works in cycles, there is likely to be a downturn every 5 or so years. During these times, your investments can lose significant value.
But don’t freak out.
By holding your assets during periods of uncertainty, you can maximize your returns and limit losses.
If you have debt, it’s a good idea to pay them off before investing. By reducing the amount of interest you pay each month, you can instead redirect this money into investment accounts.
If you have high-interest debt like credit card debt or student loans, it’s best to reduce these as much as possible before you begin investing.
If your only form of debt is a mortgage, you can start investing earlier because the returns from your investments are likely larger than the interest rate on your mortgage.
Time is your biggest asset when it comes to investing.
For those with long periods of time to invest before the money is needed you can choose a more risky portfolio strategy.
If you’re looking to retire in the next few years, you’ll want to rebalance your investment portfolio into lower risk assets so you can retire without worry.
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Some individuals are more risk adverse than others.
If monetary risk brings high anxiety, you might want to consider investing in less risky options like a high yield savings account or stock fund.
Final Thoughts on the Best Compound Interest Investments
Investing your money into compound interest accounts is like making free money.
There are many types of compound interest investments, but my favorite is investing in stocks. There is not one right answer for each individual, however. You'll want to consider your personal situation before choosing an option.
Do you have a favorite compound interest investment? Comment below!