Interest is a dirty word for many people — it's what makes them have to pay more money on debts than what they originally borrowed. However, what lots of people don't realise is that interest can also work in their favour. Oftentimes, you can earn interest on the money that you save or invest elsewhere.

There are two main types of interest but we'll take a look here at compounding interest and how it can help you achieve your financial goals.

What is compounding?

Compounding makes your money grow faster over time and here's the trick: You don't even have to do anything to make this happen. How is that possible? 

Let's say you have $100. Every month, your friend agrees to give you an additional 10%. After one month, they give you an $10 extra. Now you have $110. But next month they're going to give you 10% of 110, so you'll actually get $11. See where this is going?

This is what is meant by compounding interest: The total amount you're getting back is actually increasing after each period.

How do you make money?

OK, so what does this mean for you? Compounding can happen in a number of ways, the most common is the compounding interest you receive from the money in your savings account. But real estate and other investments offer a more lucrative way to earn from compounding. Here's how:

The real estate market is such that the value of individual properties tends to increase over time. If the initial value of the property is $500,000, and this increases by 10%, it's now worth $550,000. If the value increases by 10% again, then it's now increased by $55,000, making it worth $605,000.

How does this relate to compounding? The longer you hold the property, the faster it's going to increase in value. When it's time to sell, the amount the property is worth will be significantly higher than it was initially, and you can use this money to invest in another money-generating investment. That's compounding in action.

There are numerous different types of investments you can make that earn compounding interest. If you invest in a stock that pays dividends, you can ask your broker to automatically reinvest the amount of the dividend into other stocks, allowing the interest your receive to grow at a faster rate over time.

At Smart Money Wealth Management, we're committed to providing affordable financial advice and wealth management services to all Australians. Contact us today to get started with a free consultation.