Compound interest has apparently been called “the eighth wonder of the world” by the genius Albert Einstein who said “he who understands it, earns it; he who doesn't, pays for it.”

Honestly, Einstein probably didn't say that. But, whoever did is still absolutely correct, and any person who is wanting to start saving seriously will ultimately come across the term.

The last Australian consumer price index, which is a long way of saying “the inflation rate”, hit 5.1%, the highest it’s been in over 30 years. This has many Australians worried about the value of their savings accounts, as if it doesn’t earn interest, then that money is actually worth less than it was a year ago.

This is where compound interest can actually grow your money, and it’s not as complex as some make it out to be. It’s also lucky that Australians have a wealth of financial products which can give them some amazing ways of earning interest.

Compound interest vs simple interest

Before we discuss these financial products, we must understand where the power of compounding comes from and discuss another form of interest, simple interest.

Simple interest

Simple interest is calculated based on just the principal balance of the loan or deposit.

The formula for simple interest is: A = P (1+ r t)

A is the final amount

P is the principal amount

r is the annual interest rate

t is the time, in years

Using this formula, let's figure out how much you’d actually pay on a car loan for $10,000 at a 10% annual simple interest rate over 5 years.

10,000 (1+(0.10 × 5)) = 15,000

As you can see, you’d end up paying $5,000 in interest over that period.

Compound interest

The calculation for compound interest works by calculating the original principal plus the interest that accumulates on it every period. Compounding periods are usually monthly, quarterly, or annually.

Let’s compare the same example above using a yearly compounded interest.

The compound interest formula is: A = P (1 + r/n ^ (nt)

The new player here is n which is the compounding frequency within one year.

If you don’t have a scientific calculator available, just use this handy online tool used to calculate compound interest.

10,000 (1+0.10/1) ^ (1 × 5) = 16,105.10

Now imagine if this was the reverse scenario, and instead you invest $10,000 instead of borrowing money, the compound interest investment would have accumulated an extra $1,105.10 over the same period as compared to simple interest earnings, that’s just over $220 more a year.

That's the power of compounding, the original investment plus previous interest, earns interest, or as some have put it, “money makes money and the money that money makes, makes money.”

What investments give compound interest?

Let’s take a look at a few investment options which provide compound interest, or ones which someone could get a compounding effect from, because the sooner you start investing, the more interest you earn.

Dividend investing

Basically, dividends are a reward given by a company to its shareholders just for holding its stock, investors can choose to reinvest these dividends, buying more shares and increasing the amount of dividends they are paid.

Some dividend stocks and exchange traded funds can provide percentage yields of over 10%, even up to 30%, although most options provide somewhere between 3% to 5%.

Of course, there are risks with this, the stock market can be volatile and the price of the underlying stock could fall, meaning you’d lose money on that part of the investment, potentially cancelling out your dividend gains.

The company could also stop its dividend at any time or reduce the payment if it's fallen on hard times or economic conditions worsen. There's also the risk the company could go completely under, taking your dividend yields and your initial investment money with it.

We have a whole article on how to get started with dividend investing if this is something you’re interested in, and many people are using dividend investing to create a whole new additional money stream for themselves.

Savings account

The humble savings account has for a long time been a go-to for those looking to gain compound interest. Some decent interest rates can be found out there with a multitude of online banks cropping up which supposedly pass on the savings of not having a branch or ATMs to their customers.

As of recently, with the Reserve Bank of Australia increasing interest rates to try to tackle inflation, now is a better time to get a good interest rate for savings, but not a great time if you need to borrow money.

The best savings account right now according to Finder is a Bank of Queensland (BOQ) savings account which will see your savings grow by 3% with its annual interest rate, other savings bank accounts have an annual percentage of 2% interest and even below 1% interest.

There are a few caveats to this, you need to first of course make an account with BOQ, have an initial savings of $1,000 and make 5 eligible transactions every month to receive the 3%.

There's also the fact that even at 3% earned interest, that savings bank account isn’t outpacing the 5.1% inflation rate, meaning your money is worth about 2% less over the year.

Term deposits

Similar to a savings account, there’s also the option of term deposits, the only difference being that this “locks up” your money invested for a specified time period.

Currently, even the best yielding term deposit requires a 2 year lock-in period and earns 3.75% interest a year, still not enough to outpace current inflation rates.

The risk with term deposits, of course, is that if you find a better interest rate after say, 6 months, your money will still be locked up for another 1.5 years at the interest rate you started.

Fixed income investments

A fixed income investment is one which pays the holder either dividends or a fixed interest amount until the life of the investment ends, and investors are also repaid the original sum too.

A term deposit is sometimes considered a fixed income investment, but the most popular of this investment type are bonds.

Bonds are a type of loan to either a government or corporation, and if you buy a bond, you’re essentially lending that money to the bond issuer with interest. You’ll be paid the accrued interest on that loan and then will receive the same amount back at the end of the period.

Bonds can have periods on them of 3 to 5 years, but can go up to 10, 15 or even 30 years. They’re considered a safer investment, especially government bonds, and pay an interest rate of around 2% to 3%, though some can pay more interest, up to 5.5%.

Some of the easiest bonds to buy are government backed exchanged-traded Treasury Bonds (eTBs) which provide fixed interest payments, and exchange-traded Treasury Indexed Bonds (eTIBs) which provide interest payments linked to inflation. Both can be purchased on the Australian Stock Exchange.

Blossom app

An alternative to trying to find fixed income investments yourself is to use an app called Blossom which invests into fixed income products.

On Blossom, users buy a portion of the Blossum Fund which invests into a global basket of different government and corporate bonds with the app promising a 3% compounding interest per annum.

Even better, Blossoms investment accounts have no minimum initial deposit, so you can literally get started with one dollar.

Crypto staking

A high-risk, possibly high reward way to earn interest is through staking cryptocurrencies.

Staking cryptocurrency, like a term deposit, is when a person locks up their crypto to help secure and validate the blockchain, the network that runs the cryptocurrency.

In return, the person gets rewarded with interest though more of the crypto they staked, which is usually taken from transaction fees from others using the crypto.

The largest centralised cryptocurrency exchange Binance offers staking and the highest yield rate on its platform is for a token called AXS, which offers a 120% annual yield for a 3 month staking period, a huge amount.

But, cryptocurrencies are extremely volatile, for example in the past 3 months that same AXS token has gone from $85 to now just $23, making the 120% yield essentially useless.

If you find a cryptocurrency you truly believe in and are happy to invest in it for the long term, there is the potential to earn more of it for “free”, and also gain from its rising value, but that could be a difficult find.

Block Earner

On the theme of cryptocurrency yielding, there’s also an app for that.

Block Earner is an Australian app which offers two investment types, a 7% fixed yield account, or a variable 2% to 18% yield account.

The team says it earns the 7% interest by converting deposited Australian dollars into the crypto stablecoin USD Coin (USDC) which it then lends to what it calls “trusted partners” although it doesn’t exactly stipulate how this yield is made.

The variable 2% to 18% product facilitates access to the decentralised lending platforms Aave and Compound Finance, taking care of the crypto buying, converting and depositing. The crypto is then borrowed from users who pay a yield to you for borrowing the digital assets.

Stablecoin yielding

With how volatile the cryptocurrency market is, some have taken to a type of cryptocurrency staking called stablecoin yielding.

A stablecoin is a crypto that's meant to be pegged 1:1 to the price of a traditional currency, like the United States or Australian dollars.

One of the largest stablecoins is a US dollar pegged token called Tether (USDT) and a popular Australian dollar stablecoin is called TrueAUD (TAUD).

As you can imagine, these digital assets are popular due to the price not fluctuating and for their ability to earn some great interest.

A word of warning though, stablecoins aren’t all stable. In a recent incident, a highly popular US dollar stablecoin called TerraUSD (UST) “depegged” from the US dollar, crashing to effectively zero.

Right now TerraUSD is worth 3 cents and other stablecoins have wobbled from their dollar-pegs in recent times with the turbulent market conditions.

There are two popular places where you can earn interest on TAUD, the Australian dollar stablecoin.

Finder Earn

Finder Earn is a dedicated app for yielding TAUD, and give a base rate of 4.01% interest per year, which is a good interest rate compared to a savings bank account.

Over the past 2 months, Finder Earn has been running a promo where from May to June if a user had a balance of over 10,000 TAUD they could earn an extra 2% interest, pushing their rate up to a really nice 6.1% interest a year.

Of course, $10,000 is a lot more money most would have to invest and that promo is finishing now, but Finder Earn could run similar promos in the future, so it could be one to watch.

Crypto.com

Crypto.com is a popular cryptocurrency exchange and their “Crypto Earn” product can earn upto 2% interest a year on TAUD.

It’s a far cry from a few months ago, before Crypto.com had to slash its yielding rates some users were earning up to 10% interest per annum!

The rates are only available to a certain quota, for example at the time of writing the 2% “Tier 1” interest rate only has $4,300 worth of space left which could be taken by someone soon.

If that Tier’s quota is filled, or if a user wanted to deposit more, they would be moved to a Tier 2 or even Tier 3 rate, which is 1% and 0.3% interest rate respectively at the time of writing.

Opinions expressed in this article are not personal financial advice and should form a starting point for self research. The author doesn’t know your financial situation and isn’t responsible for any investment decisions you make.

It is recommended to read the relevant product disclosure statement (PDS) on any financial instrument and speak to a financial advisor before investing your own money. Nothing in this blog post is to be considered financial or investment advice.