The 12 Best Compound Interest Investments Ranked
Compound interest is the secret to so many investors' success, both in the stock market and beyond it. Simply put, compound interest is the capacity of capital to continue generating new capital off the back of previously earned interest. When your investments pay dividends, by reinvesting the profits (rather than sucking them out of the investment vehicle), you can generate ever-increasing income without having to continue adding to the principal. In essence, compound interest can take the place of your direct investment in an asset or asset class.
A savings account is perhaps one of the simplest ways to make sense of this process. Each month (or year) your financial institution pays out a small amount of interest to you as a way of paying you for the use of your saved cash. Savings accounts often provide very limited interest rates these days, but they serve as a potent teaching tool for anyone starting out their journey into savings and investment assets.
The interest earned on your savings account balance is added to that capital already placed in the account. During the next interest earning period, the total balance (not just the earlier principal figure) is considered as the interest-earning capital pool. Therefore, the longer you leave an investment to grow through compound interest, the greater your exponential growth within the account will be.
What is compound interest?
Compound interest relies on the creation of dividends — of some type. Dividends, in the traditional sense, are payments made to investors as a natural component of the ownership terms. Many stocks pay out cash dividends, and there is an entire subsection of index funds and ETFs that are built around the payout feature as the central draw rather than potential growth opportunities within the fund's price structure.
The key to creating compounding interest is to reinvest the dividends that you earn from your existing portfolio. You can do this by directing your brokerage account to automatically reinvest proceeds from dividends, or you can manage reinvestment yourself.
Classically, compound interest is formed around the reinvestment of profits in the same asset, but this isn't exactly a hard and fast rule. When seeking compounding profits, you simply need to reinvest payouts rather than using them to support spending needs or other functions of budgetary math. Maintaining your portfolio's ever-increasing value, with dividend profits included, is the key to creating compounding growth. Essentially, your continued growth is predicated on the continually larger principal value — with the added interest forming an integral component of that principal.
Real estate property (rentals, specifically)
One of the best dividend generators available to investors is the real estate marketplace. Specifically, rental properties offer a fantastic opportunity to build a consistent monthly income. Because of the continuous incoming financial proceeds from a rented property, you can pour profits directly into other assets in real estate or beyond it without too much hassle. Of course, a real estate property requires active maintenance, and tenants will require repairs, inspections, and other expenditures on a more or less random basis.
Keeping some of your profits aside in a management fund is crucial when it comes to maintaining a high-earning rental property. This allows you to continually add to both your pool to manage expenditures and your other investments with the profits themselves. The key to good property management is to find ways to drive your budget for the asset to break even or better.
A good yield on any particular rental property is about 5% to 8%, meaning you'll take away this much after paying for any repairs that need addressing, handling mortgage payments, managing taxes and other fees associated with the unit, and potentially paying to advertise the property and draw up terms with new tenants (which could happen every year or even more frequently in some instances). You could walk away with the profit, adding it you your own budget each month, but ideally, this profit should be reinvested somewhere else for the best possible compounding results.
Blue chip shares and dividend aristocrats
The stock market is a space in which most investors will be intimately familiar. Blue chip stocks and dividend aristocrats are some of the highest performing companies traded in the marketplace, and as a result, often make for some of the best assets to include in your portfolio when targeting compounded interest options.
Dividend aristocrats are of particular interest for traders looking to capitalize on compounded interest. These companies are long-lasting brands that have continuously increased the dividend payout each year consecutively for at least 25 years. Across the entire U.S. stock market, there are just 65 dividend aristocrats. Some aristocrats are mainstays in the consumer marketplace: Procter & Gamble, Target, Pepsi, Walmart, ExxonMobil, and Aflac are all brands that fall under the definition of this classification.
Brands that bring solid long-term growth and persistent dividend production together are often targets of investors looking to bring significant compounding into play. With continuously improving dividend payouts and a sound strategy for reinvesting those proceeds, building a long term plan to balloon your holdings—creating exponentially increasing dividend yields over time as a result of steadily lowered effective yield ratios — and actual dividend payment figures is simply a matter of time.
REIT funds
REITs are a class of stock assets that are unique in the marketplace (although other, similar commodities that track with gold, oil, and other resources do exist as well). A REIT (or Real Estate Investment Trust) is a bundling of real estate properties that are traded as a stock item, according to the U.S. Securities and Exchange Commission. In the same way that a company might own a building, fleet of vehicles, and intellectual property that allows them to deliver a product to consumers (and value as a brand that investors buy into), REITs own physical properties that are rented out to tenants.
These are organized like companies, but their assets are managed according to guidelines set out by the federal government. Fundamentally, companies budget their earnings based on a number of factors, with one being dividend payments to shareholders. But much of the profits that a company brings in are directed at expansion, bonuses, and other internal spending. REITs must, by law, provide dividend payouts of 90% of the fund's taxable income.
This isn't a guarantee of consistently huge dividends, but REITs do offer some of the most aggressive payouts on the market, in terms of dividend yield (the price of a share compared to its payout value). REITs are often a great option for creating long-lasting dividends that can be reinvested in the same commodity or elsewhere for greater portfolio diversity.
Income-focused index funds
Index funds are some of the strongest purchases that stock investors can make. Time reports that index funds are a favorite among high net worth investors and often underappreciated by those just starting out in the marketplace. Many investors want to strike it big with a great sleeper pick on an individual company, but the chances of finding the next Microsoft, Facebook, or Tesla before the rest of the market is essentially zero.
Instead, new investors and those with years of experience alike should and do flock to index funds and ETFs. These funds are traded in discreet shares in the same way as any other stock market asset, but instead of purchasing shares of a company you believe in, with an index fund you're buying a share of bundled assets (just like in the REIT marketplace). The assets compiled in a fund are shares of companies, however. Effectively, when you buy an index fund, you're buying into a huge cross-section of the broader market.
An income-driven fund is one that prioritizes dividend payouts over share price growth, and as a result, will incorporate a healthy mix of high-yielding company stocks. With the quality dividend payout, you can focus on moving the funding around into other asset opportunities, creating a diversified portfolio in the process.
Growth-focused index funds
Another approach to creating compounded earnings is through the use of growth-focused index funds and ETFs. Funds of all types are built with an algorithmic or actively managed set of internal rules. The fund management sets goals and builds a portfolio that is rebalanced on a routine basis in an effort to meet those goals. Typically, they will include an earnings target as well as parameters surrounding value defense—for instance, maintaining a certain share of consumer staples, bond holdings, or FAANG stocks that see historical price action that trends at or above market averages or perform better than average during market slumps.
An ETF may be actively managed, but an index fund is typically built around market parameters (for example, proportional stakes in every S&P 500 company, or NASDAQ 100 tech companies) that are set and maintained throughout the life of the fund. Index funds are often low costing, and provide excellent returns over the long term. Index fund options can be found to support any type of priority you may have in the market. With a growth-forward option, the fund is built around pricing targets rather than dividend creation, although with such vast portfolios there will always be dividend payouts.
Even as the dollar amount on dividends is lower than with those focused on this feature, the ability to support continued forward momentum and a compounding opportunity remain strong here.
A personalized stock portfolio
Individual stocks can provide long-ranging compound interest opportunities. Rather than relying on a fund manager or index to balance your portfolio, you can opt to invest in a variety of individual companies that make sense to you and your overall goals instead. Directing your own diversification processes is a great way to tailor dividends and general growth figures to your own strategy and research. Picking your own stocks gives you the ability to match whatever kinds of assets make the most sense to you. You can involve index funds and REITs to take advantage of their stability while also investing in higher-risk assets that payout significantly larger dividends or promise the potential for explosive growth.
It's important to think about the assets that you bring into your portfolio in relation to those you already own and those that you intend to buy in the future. While balancing your own portfolio you control the diversification and potential yield, but you also run the risk of overextending yourself in one asset class or a single company.
As with other compounding strategies, you have the option to reinvest dividends in the same asset or to move proceeds around. One strategy that individual stock pickers use here is the bucket approach: Placing stocks in A, B, and C categories that correspond to dividend payout schedules. This gives an investor a dividend payout every month of the year, leading to routine dividends for use in compounding efforts.
Investments in local business
Another potential source of compound interest gains can be found in local business investments. This approach is a little different than investments made in the stock market or other commodity marketplaces, but it is no less fruitful for those looking for a unique asset that pays out well.
A local business provides services and gives back to your community, making it a valuable investment in more ways than one. However, in strictly financial terms, investment in a local business seeking a cash infusion can give you the opportunity to extract dividend payouts every month or every quarter with consistency. In the business world, reinvesting profits can mean expanding service coverage areas, product availability, or even a totally new range of products that consumers are hungry to purchase. Alternatively, moving dividend assets out of the business itself and into new opportunities is also a viable strategy here.
Bonds
Bonds are some of the strongest long-term assets that you can invest in. They are issued by the federal government (or other governments and even companies) and create a contract between the issuer and buyer. Bonds are essentially lending products that run counter to the way that consumers typically engage them. Instead of borrowing money from a bank or financial institution, a bond is a loan to the government or another institution with guaranteed terms.
At the end of the bond's term, you can cash in the asset for the agreed price. They are some of the only guaranteed returns in the world of investing, and so they form an important hedge for many against market volatility. Reinvesting the returns in revolving bond purchases can result in a sizeable compounding of interest over the years.
However, it's important to remember that bonds provide dramatically low returns in comparison to other investment options. Because the rate is guaranteed and agreed upon before the purchase is made, the element of risk is entirely eliminated from the bond formula. Risk begets returns, so it's only natural that with effectively no risk there will be limited returns (in relation to other options that involve greater uncertainty).
Certificates of Deposit (CDs)
A certificate of deposit works in a way that's similar to bond holdings. CDs are also structured as contract purchases, but they are issued as savings products by banks. Instead of loaning money to the government in an effort to support some kind of infrastructure spending (or a war effort, as the U.S. used bonds to help support financially during WWII, you are depositing your cash into what amounts to a term-locked savings account.
CDs provide the same kinds of assured returns that a bond can provide, but the rates may be even less favorable than in the bond marketplace. One thing a CD does offer is typically shorter durations for turnover. Forbes Advisor reports that CDs can be acquired with maturity dates ranging from one month into the future all the way up to ten-year terms. This means you can turn over your investment and accrued interest faster, but rates become even smaller on shorter CD investments.
These are incredibly approachable for most investors, though. Instead of wading through bond research and investment vehicles to gain access to the marketplace, the bank you already use likely offers CDs to its users. Simply opening a CD account online or in your branch is all it takes to start your journey toward enhanced interest compounding with this product.
High yielding savings accounts
One final option in the more subdued savings space comes through a typical savings account. Savings accounts are often easy to use, with zero or limited delay on deposits and withdrawals. A savings account provides you a small trickle of earned interest on invested capital and makes for a great resource to use for emergency capital — as it earns something while performing its role of acting in quick access reserve.
With a high-yield savings account, you can boost earnings potential over the traditional rates that most big banks offer. CNBC reports that the average interest rate on all savings accounts sits at just 0.1%, but with a little bit of digging, you can find an online saver option that can balloon that return to over 1%, and perhaps even as high as 2%.
These rates aren't going to change the world, but they are far better than the middling earnings that your current bank would offer normally and can make for a highly beneficial vehicle to store emergency capital, routine cash savings, and other pools of financial resources that you want to keep out of more direct investment spaces.
Starting a local business
Savvy investors might consider starting their own business in order to create dividend profits that can be reinvested. In the same way that an investment in another local business can open up the potential for expanded opportunities to earn compounded returns, your own business provides the same basic foundation. Yet a business launched and owned by you is one that you are naturally more passionate about and maybe more inclined to continue actively managing in order to create a flourishing enterprise.
The opportunity to work for yourself is financially enticing, of course. Yet a flourishing business is one that opens up an immensity of possibility beyond simply the ability to work in a field that gets you excited to arrive at the office each morning. Launching a new business comes with all the hallmarks of local business investment, but takes these benefits a step beyond and gives you complete creative control over the direction of the company as well as 100% of the profits (or a significant margin in the event of a co-founded brand).
Online content creation
Online content creation is a less traditional approach to creating dividend income, but it's one that can be leveraged to great success. Many people are chronicling their day-to-day lives through exciting adventures in the world documented on YouTube, Medium, and in personal blogs and other outlets.
Creating online content takes a considerable commitment up front, but the unique thing about this approach to creating income is the longevity and earning power that published work enjoys. Many people speak of passive income as a goal for the future, but it's often lost on the layperson as to how this can be achieved. Simply put, passive income is cash generated through a void of effort on your part — for instance, the dividend income that you earn through savings account interest, stock investments, and other invested capital.
Instead of investing your cash, you might consider spending some of your time creating a library of content that can be monetized in perpetuity. YouTube content continues to create ad revenue for uploaders for as long as people are watching the videos, and the same can be said for other avenues of content building. Investing time to reap financial rewards is a great way to create a trickle (or more substantial flow, in some instances) of income that can be easily reinvested elsewhere.