Compound interest is basically interest that continues being earned on an original sum of money invested along with the previous interest for a specified length of time.

For ease of explanation lets take 1000 dollars put into a bank account that is guaranteed to earn a 10% interest compounded semi annually. After 6 months you would have your preliminary amount plus 100 dollars, or a value of 1100 total. The second 6 months the bank will give you the 10% on 1100 which equals 110 for a total 1210 dollars at the end of the year. From this example it is easy to see that compound interest adds up quickly and the term compound is being used correctly in this scenario. The term compounding is used for specified periodic time frames.

Mutual funds are a some what different investment vehicle than a regular savings account. You still start out with purchasing an initial sum of money. This amount buys a number of shares in this organization. You own shares rather than just money. The management board of the fund are people, well versed in various methods to make money in just about any area you can imagine such as stock markets, currencies, commodities and many others. In short you are buying their expertise and pooling your money with many other investors.

The term compound is not exactly the correct way to evaluate how the fund is performing. You receive dividends based on their performance, which are re-invested back into the fund giving you more shares. So instead of accumulating just money, you are accumulating even more shares. The more shares you own each time a dividend occurs the more new shares you receive and so on.

How often do mutual funds dividend, would be the correct way to express the question at hand. The share prices go up as they make money until management decides it should dividend. Dividends lower the cost of the shares again to a more reasonable level that new investors will feel comfortable buying. Keep in mind these management experts charge a fee for their worth, and usually there is a transaction charge either up front or when you sell your shares. This fee cost tends to make this type of dividend investing a longer term device.

All funds have a prospectus just like a stock and will give you the details of their track record over a number of years. The number of times it has performed a dividend cycle will depend on its management’s success in making money, it is not periodic like a bank account.

Here are a few charts that showcase how many years it takes to reach each $1 million threshold given that you regularly invest and earn a decent rate of return.

To go from $0 to $1 million:

Monthly Contribution	8% Return	9% Return	10% Return	11% Return
$100	52.9 years	48.3 years	44.5 years	41.4 years
$250	41.6	38.3	35.5	33.1
$500	33.4	30.9	28.8	27.0
$1,000	25.5	23.9	22.4	21.2
$1,291.66	22.8	21.4	20.2	19

To go from $1 million to $2 million:

Monthly Contribution	8% Return	9% Return	10% Return	11% Return
$100	8.6 years	7.7 years	6.9 years	6.3 years
$250	8.5	7.5	6.8	6.2
$500	8.2	7.4	6.7	6.1
$1,000	7.8	7.1	6.4	5.9
$1,291.66	7.6	6.9	6.3	5.7

To go from $2 million to $3 million:

Monthly Contribution	8% Return	9% Return	10% Return	11% Return
$100	5.1 years	4.5 years	4.1 years	3.7 years
$250	5.0	4.5	4.0	3.7
$500	4.9	4.4	4.0	3.6
$1,000	4.8	4.3	3.9	3.5
$1,291.66	4.7	4.2	3.8	3.5

That $1,291.66 number didn’t come out of thin air — it represents the current maximum monthly contributions available in a 401(k) or 403(b) account for most people. What these charts mean is that you can go from $0 to $3 million in somewhere between 28 and 35 years with a bit of determination to take advantage of the opportunities you have available. Most of that time is spent getting to that first million. Once you hit that milestone, compounding really takes over to help you reach your ultimate goal.

Source: Fool.com

So, I’ve decided to give them a proper answer: How much interest do you earn on a million dollars? The answer is, of course, it depends.

It depends on several factors including: What is the interest rate? Over what period of time? How often is the interest calculated and paid during the period?

What is the interest rate?
Obviously the higher the interest rate, the better. Even small differences result in large amounts of money over long periods of time. As a practical example, we’ll use a 4% interest rate which is easily available with a high interest online savings account (update: rates have dropped since this was originally published).

Over what period of time?
The longer the better. Compound interest works it’s magic best over long periods of time. I’ll give a couple of examples using different periods of time.

How often is the interest calculated and paid?
The more often, the better. Is the money compounded yearly, quarterly, monthly, or daily? For our example we’ll assume the money is compounded monthly.

So, to answer the question, how much interest do you earn on One Million Dollars (assuming a 4% interest rate, compounded monthly)?

One Day – $109.59

One Month – $3,333.33

One Year – $40,741.54

Five Years – $220,996.59

Ten Years – $490,832.68

Twenty Years – $1,222,582.09

So, it doesn’t take long for the money to really add up. And there are a lot of ways to get a higher interest rate than 4%. You can use a compound interest calculator to experiment with different interest rates, periods of time, and compounding periods.

Compound Interest has also been called the eighth wonder of the world and the greatest mathematical discovery of all time.

Fortunately for the rest of us, you don’t have to be a genius to understand compound interest. In fact, it’s pretty simple.

The concept is this: When you invest money you earn interest on your capital. The next month, you earn interest on both your original capital and the new interest. The third month you earn interest on your capital and the first two month’s interest. You get the picture. The concept of earning interest on your interest is the miracle of compounding.

It’s very much like a snowball effect. As your capital rolls down the hill it becomes bigger and bigger. Even if you start with a small snowball, given enough time, you can end up with an extremely large snowball. Over the period of many years, the returns you get from compounding will eventually outpace your initial contributions.

As an example, if you invest $2,000 a year at the age of 14, at a 10 percent annual rate of return, and you set aside the same amount at the same return for the next four years. In other words, you put aside a total of $10,000 over five years, beginning when you’re 14 and stopping when you’re 18. If you don’t invest another penny and your money keeps growing at the same rate of interest, you’ll have almost $1.2 million by the time you’re 65.

Most of us aren’t 14 anymore, but the point is, with compound interest, the sooner you start, the better.

Compound Interest can be a fantastic thing when you’re saving or investing money. Unfortunately, it works in reverse when you’re borrowing money and it explains why debts often spiral out of control.

If your credit card has a high interest rate and you can’t afford to pay off much each month, then it’s the credit card company that is getting the benefit of compound returns.

Understanding the power of compound interest can be a huge motivator in helping you get out of debt and start building wealth.

There are dozens of compound interest calculators, including this one, available on the internet. Try one out, see what compound interest can do for you, and start saving today.

“Those who understand compound interest are destined to collect it. Those who don’t are doomed to pay it.”