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Compound interest is an important concept to understand when saving or investing money. It refers to the interest earned on the principal amount and any accumulated interest from previous periods. Compounded interest can help you earn more on your money than simple interest, which is why it is often referred to as "compounding your wealth" or "earning money on your money."
Compound interest works in two stages. Firstly, the account holder earns a stated rate of return on their initial principal (also called the “balance”). Secondly, the interest earned accumulates with each new period and compounds upon itself. This means that additional interest is earned on top of the original principal, resulting in a higher total return.
Calculating compound interest differs slightly from calculating simple interest. The formula for simple interest consists of multiplying the principal by the rate of interest and then dividing by 100:
Simple Interest= Principal x Rate of Interest/100
The formula for compound interest involves multiplying the principal by one plus the rate of interest to the power of the number of time periods:
Compound Interest= Principal x (1 + Rate of Interest)^Number of Time Periods
For example, if an investor has $2,000 invested at a 10% return over a 20 year period, the compound interest would equal $7,503.75 ($2,000 x 1.10^20). Whereas with simple interest, this same investment would yield just $4,000 ($2,000 x 10% x 20 years).
It's important to consider compound interest when making any type of financial decisions. As you can see from the example above, it can add up quickly and help you maximize your returns. Keeping an eye out for higher rates of return can lead to greater rewards in the long-term - so make sure you're prepared to take advantage of compounding whenever possible
Compound interest works in two stages. Firstly, the account holder earns a stated rate of return on their initial principal (also called the “balance”). Secondly, the interest earned accumulates with each new period and compounds upon itself. This means that additional interest is earned on top of the original principal, resulting in a higher total return.
Calculating compound interest differs slightly from calculating simple interest. The formula for simple interest consists of multiplying the principal by the rate of interest and then dividing by 100:
Simple Interest= Principal x Rate of Interest/100
The formula for compound interest involves multiplying the principal by one plus the rate of interest to the power of the number of time periods:
Compound Interest= Principal x (1 + Rate of Interest)^Number of Time Periods
For example, if an investor has $2,000 invested at a 10% return over a 20 year period, the compound interest would equal $7,503.75 ($2,000 x 1.10^20). Whereas with simple interest, this same investment would yield just $4,000 ($2,000 x 10% x 20 years).
It's important to consider compound interest when making any type of financial decisions. As you can see from the example above, it can add up quickly and help you maximize your returns. Keeping an eye out for higher rates of return can lead to greater rewards in the long-term - so make sure you're prepared to take advantage of compounding whenever possible
