How to Invest to Get Compound Interest

You can invest your money in a variety of different types of instruments that pay interest. However, on some types of investments, including most types of bonds, the interest payments are regularly disbursed by the bond issuer. Your investments grow faster if you allow your interest to compound, which involves leaving your interest in the investment so that you can earn interest upon your interest. Most banks allow you to compound interest on certificates of deposit. Interest payments compound on savings accounts if you do not make any account withdrawals.

Step 1

Review your finances to determine how much money you can afford to invest. Contact local banks and credit unions and find out what rates you can earn on the sum that you intend to invest if you buy a CD or invest in a money market or savings account. Contact investment brokers and ask about brokerage CDs because the interest rates on these securities are often higher than on bank CDs.

Step 2

Divide the number 72 by the interest rates that different institutions offer to pay you on a CD or savings account. The result of this calculation reflects the number of years it will take for you to double your money if you allow your interest to compound. Investment analysts call this equation "the rule of 72," but it takes much longer to double your money if you do not allow the interest to compound.

Step 3

Open a CD or savings account at the bank or financial institution that enables you to grow your money the fastest. When you open the account, explain that you want the interest to compound and that you do not wish to receive interest checks. Sign the new account disclosures and keep a copy on file in case the bank accidentally disburses your interest payments.

Tip

Interest payments on CDs are taxable but you can grow your compounding investments even faster if you buy a CD or similar type of investment with qualified funds. Retirement accounts contain tax-qualified funds, which means that you pay no taxes until you withdraw money from the account. If you have a tax-deferred account, the money that you would otherwise pay in taxes actually earns interest and that interest compounds. Therefore, your account grows much more quickly than in a taxable account. Deposits to retirement accounts are subject to annually adjusted income restrictions and dollar-based contribution caps.

Warning

If you invest in a taxable CD, you have to pay tax on your earnings even if you allow the money to compound. You pay taxes on your earnings in the year that you receive the money or the year that the money gets added to your account. Therefore, on a CD of 12 months or less, you receive your money before you pay your taxes because taxes are not due until the end of the tax year, which occurs on 15 April in the year following the current calendar year. However, if you have a multi-year CD with compounding interest, you do not receive any interest until the CD term ends even though you have to pay taxes on an annual basis during the CD term. Therefore, do not allow your interest to compound unless you have sufficient cash reserves to cover your tax liability during each year of the CD term.

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