Absolutely right! Since you’ve grafted to earn your money, it should work hard for you too. Investing in the best compound interest investments effectively lets your money do the legwork. These are widely recognised as some of the most powerful tools for long-term wealth building.
There’s a well-known saying: “Compound interest is the eighth wonder of the world.” While Albert Einstein is often credited with the quote, fact-checkers tend to disagree.
Regardless of its origin, the wonder of compound interest can transform your life wherever you are, even if you haven’t had the chance to see the Great Wall of China or Machu Picchu!
By using the right approach and a combination of the best investments, you can harness the power of compound interest and grow your wealth. Let’s delve into how it works and explore the top seven compound interest investments!
7 Best Compound Interest Investments
Looking for ways to start growing your income? This list is a brilliant place to begin! We’ll explore seven assets that benefit from compound interest investments, along with some tips to make the most of them.
1. High-Interest Savings Accounts
High-interest savings accounts, also known as high-yield accounts, are a fantastic option for harnessing compound interest investments. They’re some of the safest, easiest, and most convenient investments out there. In my opinion, everyone should have one!
However, it’s important to note that many traditional savings accounts offer very low interest rates. A quick online search might reveal rates as low as 0.01% APY (Annual Percentage Yield) at some high-street banks. That kind of interest won’t see your money compounding very quickly.
On the flip side, high-interest savings accounts can offer rates that are considerably higher than the national average. These accounts are usually found with smaller banks or online banks, rather than the big high-street names.
Online banks can pass on higher yields to customers because they have lower running costs than their brick-and-mortar counterparts.
Even better? Many of these banks offer daily compounding of interest. This means the interest you earned yesterday gets added to your balance each and every day.
That interest then starts earning its own interest straight away! Typically, all the interest you’ve accrued will be paid out in one lump sum at the end of each month.
How to invest in a high-interest savings account
There are a number of high-yield savings accounts available from various banks and building societies. It’s worth checking out investopedia’s list here to see which accounts are currently offering the best returns. Remember to be thorough and check the terms and conditions of each account, including any potential fees.
2. Certificates of Deposit (CDs)
Considering locking away some of your savings for a set period? Then certificates of deposit (CDs) could be a good option – and we’re talking about the financial kind, not the music kind!
Essentially, CDs are fixed-term, fixed-rate investments. You commit to investing a set amount of money for a predetermined period, which can range from a few months to over five years.
As a rule, the interest rate offered on CDs increases the longer the term. Savers have two options when their CD matures: they can either withdraw the money or use it to purchase a new one.
It’s worth noting that while savings accounts typically offer lower interest rates than CDs, this isn’t always the case. Be sure to consider all your options before making a decision. Additionally, most savings accounts pay compound interest investments, although the frequency of compounding will vary depending on the specific provider.
One drawback of CDs compared to savings accounts is their lack of flexibility. Unlike a savings account where you can access your money at any time, CDs typically come with early withdrawal penalties if you need your money before the term ends. This can be a good thing for those who struggle with impulse spending, as it essentially “forces” you to save.
How to invest in a certificate of deposit
Looking for a higher interest rate than a traditional savings account? Many banks and building societies offer CDs. You can start your research using a comparison site like Investopedia to find the current best CD rates. The key thing to consider is how long you’re comfortable locking your money away for.
3. Bond Funds and Corporate Bonds
It’s not just the government that issues bonds! Companies can also issue debt instruments called corporate bonds. When you invest in a corporate bond, you’re essentially lending money to a company to help them fund their growth or day-to-day operations. In return, you receive regular interest payments.
Bond funds are similar to individual bonds, but instead of putting your money into a single bond from one company, you’re investing in a collection of bonds managed by an investment firm. This diversification helps to spread out your risk, as it means you’re not reliant on the performance of any one company meeting its debt obligations.
It’s important to understand that traditional bonds, while offering regular interest payments, typically don’t benefit from compound interest. The exception to this are zero-coupon bonds.
Zero-Coupon Bonds
These bonds don’t pay regular interest payments. Instead, the bond is sold at a discount to its face value and the difference is considered your interest earned. When the bond matures, you receive the full face value, effectively giving you a lump sum payment that reflects the interest earned over time.
Investing in Bond Funds and Corporate Bonds
To get started with bond investments, you’ll need a brokerage account. Popular platforms include Hargreaves Lansdown, Fidelity International, and AJ Bell YouInvest. These platforms allow you to invest in a variety of financial products, including bonds, bond funds, and shares. Bond funds can be a great way to begin investing as they offer a good balance of risk and return.
4. Peer-to-Peer (P2P) Lending Opportunities
Most of the high compound interest investments options we’ve explored so far involve indirect lending. You invest your money, and an intermediary like a bank or investment firm handles the loan details. Peer-to-peer (P2P) lending cuts out the middleman and gets you closer to the action.
P2P lending platforms connect you with individuals or businesses looking for loans. You can lend directly to them and earn interest on the loan in return. By reinvesting your interest into more loans or other investments, you can benefit from compound interest.
While P2P lending can offer attractive interest rates compared to some of the other options on this list, it’s important to be aware that it also carries a higher degree of risk. If a borrower defaults on their loan, you’ll lose the money you lent them.
P2P lending tends to attract investors who want to be more hands-on with their investments compared to simply buying stocks and bonds.
For instance, there can be a real sense of satisfaction in supporting the growth of a company whose values you admire.
How to invest in peer-to-peer (P2P) lending opportunities
It’s important to choose a reputable P2P lending platform that aligns with your needs. Some platforms have stricter criteria for investors, such as minimum income or net worth requirements.
Here are some popular P2P lending platforms in the UK to get you started (conduct your own research to ensure they’re a good fit for you) include: Ratesetter, Zopa, LandlordInvest.
5. Dividend-Paying Stocks
While not technically interest-bearing investments, dividend-paying stocks are excellent examples of how to achieve compound growth.
Dividend-paying stocks are shares in a publicly traded company, just like any other stock. The value of a dividend stock can fluctuate based on market conditions and the company’s performance.
Dividend-paying stocks are unique because they distribute a portion of their profits to shareholders on a regular basis, often quarterly. These payouts are called dividends. By reinvesting your dividends to purchase additional shares, you can turn this into a compounding investment that increases your overall dividend income over time.
It’s important to be aware of the risks involved. Companies are not obligated to pay dividends, and they can choose to stop them altogether at any time. Additionally, relying solely on dividends for income isn’t advisable as the company’s stock price could decline.
How to invest in dividend stocks
You can buy individual dividend-paying stocks through any stockbroker. Alternatively, to spread your risk, you can invest in dividend funds which hold a basket of different dividend-paying stocks.
Dividend funds can either reinvest your dividends automatically to purchase additional shares (compounding your returns), or they can pay the dividends out to you as income.
6. ETFs and Index Funds
Exchange-traded funds (ETFs) and index funds are similar investment options. Both are essentially collections of assets, such as bonds, shares, and other holdings, that track a particular underlying index. The most well-known example is the FTSE 100 index.
Exchange-traded funds (ETFs) and index funds are similar investment options, but there’s a key difference in how you buy and sell them. ETFs trade throughout the day on a stock exchange, just like individual stocks.
This means you can buy and sell them at any point during market hours at the current market price. Index funds, on the other hand, can only be purchased or redeemed at the end of the trading day, at the closing price. They are also typically purchased directly from the fund provider, and some may have minimum investment requirements.
Despite these differences, both ETFs and index funds are considered excellent long-term investments. This is because they are inherently diversified, meaning they hold a basket of different assets.
By investing in a total market fund, for example, you can effectively own a small slice of the entire UK stock market! This diversification helps to spread out your risk and smooth out market fluctuations.
Many brokers offer the option to automatically reinvest your dividends. This means your dividends are automatically used to purchase additional shares, which can help your investment grow over time due to compounding.
How to Invest in ETFs and Index Funds
You can buy ETFs through any stockbroker or trading platform. Many large investment firms offer their own index funds in addition to those available from other providers. Do some research on index fund investing to see if it’s the right choice for you.
7. REITs and Real Estate
Perhaps you’re interested in real estate? Real estate investment can offer a steady stream of income and has the potential for good returns, compared to other asset classes.
Direct real estate investment involves buying buildings, be it residential or commercial, and then renting them out to generate income. This approach offers the potential for good returns but requires a significant initial outlay to purchase and prepare the property.
The income you receive from rent can be used to improve your existing properties or even buy new ones, allowing you to build your property portfolio over time.
If the idea of being a landlord doesn’t appeal to you, there’s another way to invest in real estate: Real Estate Investment Trusts (REITs). These are essentially companies that own and operate income-producing real estate.
By law, REITs must distribute at least 90% of their taxable profits to shareholders as dividends. These dividends can be reinvested to grow your holding in the REIT and potentially increase your returns. This offers a more hands-off approach to real estate investment.
How to Invest in Real Estate/REITs
No matter if you choose direct real estate investment or REITs, thorough research is the first step. This should involve investigating locations, property types, and financing options for physical real estate. You’ll also need to do some calculations to estimate potential profit margins.
The good news is that REITs can be bought through a stockbroker, just like you would buy shares in an index fund.
Ultimately, the best approach depends on your investment goals and risk tolerance. There are plenty of resources available online and through libraries to help beginners learn more about real estate investing. Do your research and decide what path is best for growing your wealth!
If you have a significant amount of money to invest, spreading it across different compound interest investments can be a smart way to diversify your portfolio and manage risk.
What is Compound Interest?
Imagine your money not just sitting there, but actually growing on its own! That’s the power of compound interest, often described as “earning interest on interest.”
Let’s see how compound interest investments work using a simple example. Say you deposit £1,000 in a savings account that offers 2% interest annually. In the first year, you’ll earn £20 in interest, bringing your total balance to £1,020.
Now, here’s the wonder: in the second year, you’ll not only earn interest on the original £1,000, but also on the £20 you earned the previous year. This means you’ll earn slightly more interest in the second year (£20.40), bringing your total balance to £1,040.40.
As you can see, compound interest investments allow your money to grow exponentially over time. The longer you leave your money invested and reinvest your earnings, the greater the snowball effect becomes.
Banks operate by using your deposited funds to make loans to borrowers. They charge interest on these loans, and a portion of this interest is paid to you as a reward for depositing your money with them. This is how you earn interest on your savings. The government protects your deposits up to a certain amount through a financial protection scheme, so you don’t have to worry about the bank itself failing.
There are two main types of interest: simple interest and compound interest.
Simple vs Compound Interest
Simple interest is calculated only on the initial amount you deposit, also known as the principal. So, the amount of interest you earn each year remains the same.
Compound interest is often referred to as “interest on interest.” This is because the interest you earn each year is added to your principal amount. So, your balance grows over time, and you start earning interest on the interest you’ve already accumulated. This can significantly increase your earnings over the long term.
The beauty of compound interest is that it keeps growing on itself over time. The interest you earn each period (daily, monthly, quarterly, etc.) gets added to your principal balance. This means you then earn interest on the increased amount, not just the original amount you invested.
Here’s a key difference:
Simple interest is calculated only on the initial principal amount you invest. You earn the same amount of interest each period, regardless of how long your money is invested.
Compound interest, on the other hand, factors in all the accumulated interest, leading to a constantly growing balance and accelerating returns over time.
Now you’ve cracked the code of compound interest and explored some of the most profitable investments to make the most of it, it’s time to share your newfound knowledge! Let’s build a community of savvy investors.
