Beginners guide to compound interest and investing

Simple vs compound interest 

Simple interest is calculated only on the principal amount and not plus the principal earned, like in compound interest. That means that with simple interest, your money grows in a linear manner and at a slower rate. In compound interest, money grows exponentially and at a higher rate.

With simple interest, the principal amount remained fixed, while with compound interest, the principal amount is shifted as interest compounds over time.

Simple interest is popular for short-term use, while compound interest is best for long-term investment.

Best compound interest account for beginners

Simple accounts 

• High-yield savings accounts

This is a savings account that offers a variable interest rate higher than ones offered on regular savings accounts. These accounts can pay up to over 12% interest rates compared to national accounts.

This method offers fluidity, as you can withdraw your money when you need it.

• Certificates of Deposit (CDs)

This is an agreement between a financial institution and an individual to deposit a set amount of money with a fixed term and interest rate. In return, you earn a higher interest rate than a regular account for agreeing to keep your money fixed in that account for the set time period.

If you decide to withdraw your money before the period ends, then you incur a penalty.

• Investment accounts 

These accounts hold bonds, securities, funds, stocks, cash, and other securities. The value of this type of investment can fluctuate, which means it can rise or decline, so a proper planning strategy is needed.

They include Registered Retirement Savings Plan (RRSP), Savings Plan (RRSP) that lets you save or invest for your retirement, Tax-Free Savings Account (TFSA), Registered Education Savings Plan (RESP), and Registered Retirement Income Fund (RRIF), amongst others.

• Retirement accounts (401(k), IRA)

Individual retirement accounts are accounts that hold up funds for retirement but with tax advantages (IRA). They include traditional IRAs, Roth IRAs, Simplified Employee Pension (SEP) IRAs, and Savings Incentive Match Plan for Employees (SIMPLE) IRAs.

Tax benefits can include total tax exemptions or tax deferrals (tax on income deferred to a later date) 

Advanced investment portfolios 

• Stocks

These represent ownership in a company as expressed by shares or equities. Identify a stable company with good financial growth annually and buy stocks if available.

It has long-term growth potential, and dividends can be reinvested.

• Mutual Funds 

This involves sharing investment as it pools assets from various investors, such as stocks, and in turn invests them in a diversified portfolio for returns.

An advantage is that investments are diversified, reducing risks of total loss. There is also  automatic reinvestment

• Exchange-Traded Funds (ETFs)

These are investment funds that trade on stock exchanges like individual stocks. They hold a collection of assets, including but not limited to bonds or commodities. They are designed to track the performance of a specific index, sector, or investment strategy.

They are low-cost and compound-friendly, hence a good choice for beginners. There is also flexibility of trading.

• Bonds 

A bond is a type of fixed-income investment where the investors loan out a certain amount of capital to banks or government bodies and offer to repay the principal amount plus interest at a later date to the lender.

It offers a lower risk margin but with a slower growth rate.