Do mutual funds pay interest? Indeed they do. And what's more, mutual funds offer one of the easiest ways for investors to reap the benefits of compound interest (the practice of paying interest on accrued interest). Opting to reinvest a mutual fund's dividends results in purchasing more shares of the fund. More compound interest accumulates over time, and the cycle of purchasing more shares will continue to help the fund, and one's initial investment in it, grow faster in value.

Compound Interest Adds up Fast

For an example of how compound interest can build wealth over time, consider a mutual fund opened with an initial investment of $5,000 and subsequent ongoing annual additions of $2,400. With an average of 12% annual return over 30 years, the future value of the fund is $798,500. The compound interest is the difference between the cash contributed to an investment and the actual future value of the investment. In this case, by contributing $77,000, or a cumulative contribution of just $200 per month over 30 years, compound interest comes to $721,500 of the future balance.

Anyone Can Benefit From Compound Interest

You do not have to be rich or a trading whiz for compound interest – one of the simplest and most useful concepts in finance – to work. You have to understand the time value of money and start investing as soon as possible. The principle works the same whether you invest $20 or $20 million. By adding the interest earned back into the original capital investment, the fund's value grows at an increasing rate.