Savings – Compound Interest and the Rule of 72

Published: 06-16-2009

Views: 19,748

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Bill Gerhard, AAA’s director of Financial Services, explains compound interest and the Rule of 72 as it applies to CDs.

How to invest in CDs, Money Markets & Savings AccountsCompound Interest and the Rule of 72Bill Gerhard: Hi! I'm Bill Gerhard, Director of Financial Services for AAA. This video series discusses how to invest in CDs, Money Markets and Savings Accounts. Now I'll explain Compound Interest and the Rule of 72.

When you're saving the Financial institution adds interest to your savings at a regular interval. This interest on interest is called Compound Interest. Two acronyms that confuse people are APR and APY. APR stands for annual percentage, APY stands for annual percentage yield. It's APY that represents your compound interest, the APY percentage will always be higher than the APR. Interest can be added to your account at any time, daily, monthly or annually. Daily interest is most common, the more frequent the compounding the more you earn. Check with your savings institution to see how often they compound. When you're researching savings parts be sure to compare apples to apples, APY to APY. Another way to see the power of compounding is with the Rule of 72, if you divide 72 by the interest rate you're earning you get the number of years it takes to double your money.

Let's take a look at an example, at 3 percent funds double in 24 years. So how do you use this information to make your money work harder for you? We have three simple recommendations. First, Start now, time fuels compounding, the more time you give your funds to grow the more compounding will benefit you. Second, save for the long term. A healthy person at age 65 needs to be prepared to finance retirement into his or her 80s and third, invest in tax-favored retirement plans, that would include retirement accounts such as an IRA or CD which allows you to maximize compound growth by providing pretax compounding.

AAA offers you information in this video series for educational purposes only. Carefully consider objectives, risks, expenses and tax implications before investing.

I hope this has helped you understand more about Compounding Interest. In our next video, I'll share some information on where to open an Account.