If you think that the safest solution for your money is to keep it under the mattress or in term deposits, this week's Contas-poupança article explains a concept that all Portuguese should know about while still at school: compound interest. It can make a huge difference to your wallet. How to earn more money with the same effort Using compound interest (or interest capitalization, which is the same thing) is a way of multiplying your money several times over, with as little effort as possible. See how time can be your savings' best ally. Imagine you plant a tree. The first year it's small and bears 10 fruits. The second year it grows bigger and bears more fruit. From these fruits, you use the seeds to plant new trees, which in turn also grow and bear new fruit until you have a large orchard that never stops growing. It may sound strange, but you can also multiply your money using the same formula. This concept is called compound interest: the money you earn in interest can be spent or... you can sow it to generate even more money over time. It's the best way to put your money to work for you. A waste of money Due to a lack of financial literacy, a large proportion of Portuguese people make term deposits and, at the end of the year, receive the interest on their current account. What happens is that they almost always end up spending the interest instead of reinvesting it in the same deposit or in other more profitable investments. It's a matter of choice: either you consume it or you invest it again, adding to your previous savings. The Portuguese waste millions of euros every year simply by having thousands of euros in their current accounts earning zero or little more than that. And even term deposits are no exception. By always keeping the same amount, you're losing money to inflation. READ MORE: How compound interest works Imagine you have 10,000 euros in savings. After a year, you receive 250 euros in interest on your current account and everything goes back to the beginning. The secret of compound interest is to take that interest and make a new deposit, but adding the 250 euros you received in the meantime. In other words, the initial deposit the following year should be 10,250 euros or more, if you have the option. Otherwise, your money will never really grow. But there is a problem. You'll need a lot of patience to see big results. You only start to see results after the first 10 years. Then the "miracle" of compound interest happens: your money starts to "explode". The amounts you can achieve with this strategy can be staggering. I used one of the many compound interest calculators you can find on the internet. Just search for it. If you start with 1,000 euros and invest 50 euros a month in a PPR fund (which has no guaranteed capital) that earns an average of 6% over 40 years (from age 25 to 65), you should expect to have 110,000 euros at the end. But you've only invested 25,000 euros (1000+(50x12x40)). If you chose, for example, an SP 500 ETF which has yielded an average of 10% over the last few decades, the result would be almost 370 thousand euros. With exactly the same effort of 50 euros a month, The fabulous effect of compound interest That's why I tell you that you should set up one or more investments for your children every month as soon as they are born. That way, when they reach the age of 20, they will already have the results they would have had at 40 if they had started at 20. With 50 euros a month, starting as soon as they are born, in an ETF that earns 10% a year, they will theoretically reach the age of 60 with 2,374,760 euros. Yes, more than 2 million euros. I repeat: with 50 euros a month. See how important financial literacy is? Someone said (they say it was Einstein, but I couldn't confirm it) that compound interest is the 8th wonder of the world. When it comes to money, it's really true. It's a difficult mathematical formula to understand, but the sooner you start using it, the sooner you'll see the effects on your bank account. All you need is time and discipline. It's not easy, but it can be very worthwhile. You can listen to the full interview here How does compound interest work? (Carlos Daniel Santos, Professor of Economics at ISEG) Pedro Andersson