by Michelle Tuesday

Created on: December 04, 2009   Last Updated: December 15, 2011

Generally speaking, compound interest is not better than capital gains, if you compare historical returns on comparable investments. This is because interest-bearing accounts earn less in returns than stock investments. These days, you're lucky to find a savings account worth more than 1.5% in interest. During a recession, capital gains aren't wowing the investing crowd either, but smart stock investments are still beating interest-bearing accounts in returns.

However, compound interest does have one things going for it that capital gains simply can't touch: stability.

Interest-bearing accounts are stable, low-risk investment options. Typically, these accounts are insured, minimizing risk altogether. The guaranteed compound interest works in your favor, and more so when compounded more frequently, because interest can earn interest of its own.

For example, if you invest $1,000 in a savings account earning 1% in interest per month, you will earn $10 in interest by the end of the month. In month two, you earn interest on all $1,010, rather than just the $1,000. If interest is compounded more frequently, every day for example, the interest will grow even more quickly. If the interest compounds only once a year, then the interest will grow more slowly.

Bottom line, compounding causes an ever-accelerating rate of account growth. Because of compounding, your savings will grow faster and faster as each day, month, or year passes, even if you never put another dime into the account. And because the account is stable, you are guaranteed that compounding.

Capital gains, on the other hand, are not guaranteed. When you realize earnings on a share of stock, you still only own one share of stock. Admittedly, the share you own is now worth more money, but it could lose value in the future. The account is not guaranteed to grow faster and faster, because the additional money in your account is not interest, and therefore is not reinvested into the account. Instead, it is simply the current value of the single share of stock you own. It grows not at a steadily accelerating rate as compound interest does, but only as fast as the company you are investing in grows.

Admittedly, some companies grow quickly, and most companies see overall growth over the long haul. Therefore, capital gains have still historically earned more than interest-bearing accounts. The risk you take when investing in a stock is that the company, and therefore, its stock, will lose value. If you have a lot of time on your hands for company research and another reliable source of income, it might be worth the risk. Over time, stocks tend to trend upward, so you should expect to see capital gains even if the company sees minor dips along the way. But invest wisely, and know the abilities of the company or fund you choose to buy shares in, because if the company or fund folds altogether, you lose your investment entirely.

Compound interest takes time to grow as well, and interest-bearing accounts offer a safe, reliable alternative to capital gains.

Michelle Tuesday is a small business owner in Gahanna, Ohio.

Learn more about this author, Michelle Tuesday.
Click here to send this author comments or questions.