How to develop a savings plan, using compound interest

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Ready to begin building up a healthy amount of savings? First, it's important to understand the very cool concept of compound interest, and to do that you'll need to know the difference between an interest rate and yield.



Yield represents the interest that will be earned not only on your investment amount but also on your interest as it builds. The interest paid on the interest you've already accumulated is called compound interest.


But when interest is paid more frequently, the yield rises. That's because the interest payment is credited to the CD more quickly and it starts earning interest along with the invested principal.


Annual vs. compounding interest

Annual interest


$10,000 x 5% x one year = $500 interest

Total interest: $500

Annual yield


$10,000 x 5% x 0.5 years = $250 interest


$10,000 x 5% x 0.5 years = $250 interest


$250 x 5% x 0.5 years = $6.25 interest

Total interest: $506.25


To get that yield you must reinvest the interest. That's what compound interest is all about.


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