Compound interest is a concept in finance and mathematics that refers to the interest earned on both the initial principal amount and the accumulated interest from previous periods. In simple terms it means earning interest on interest.
Unlike simple interest which is calculated only on the original amount of money invested compound interest takes into account the interest already earned and adds it to the principal for the next calculation of interest.
The formula for compound interest is:
A = P(1 + r/n)^(nt)
Where:
A is the future value of the investment/loan including interest
P is the principal amount (initial investment/loan)
r is the annual interest rate (expressed as a decimal)
n is the number of times that interest is compounded per year
t is the number of years
Let's understand this formula with an example. Suppose you invest $1000 in a savings account that offers an annual interest rate of 5%. If the interest is compounded annually (n = 1) and you keep the money invested for 3 years (t = 3 the future value of your investment (A) can be calculated as:
A = 1000(1 + 0.05/1)^(1*3)
A = 1000(1 + 0.05)^3
A = 1000(1.05)^3
A ≈ $1157.63
As you can see the compound interest has helped your investment grow to $1157.63 over the 3-year period. This is because the interest earned in each year is added to the principal and contributes to the calculation of interest in subsequent years.
Compound interest can be powerful in helping investments grow over time. It is commonly used in various financial products such as savings accounts certificates of deposit (CDs bonds and loans. By understanding and harnessing the power of compound interest individuals and businesses can make informed decisions and potentially maximize their returns or savings.
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Compound interest is a concept in finance and mathematics that refers to the interest earned on both the initial principal amount and the accumulated interest from previous periods. In simple terms it means earning interest on interest.
Unlike simple interest which is calculated only on the original amount of money invested compound interest takes into account the interest already earned and adds it to the principal for the next calculation of interest.
The formula for compound interest is:
A = P(1 + r/n)^(nt)
Where:
A is the future value of the investment/loan including interest
P is the principal amount (initial investment/loan)
r is the annual interest rate (expressed as a decimal)
n is the number of times that interest is compounded per year
t is the number of years
Let's understand this formula with an example. Suppose you invest $1000 in a savings account that offers an annual interest rate of 5%. If the interest is compounded annually (n = 1) and you keep the money invested for 3 years (t = 3 the future value of your investment (A) can be calculated as:
A = 1000(1 + 0.05/1)^(1*3)
A = 1000(1 + 0.05)^3
A = 1000(1.05)^3
A ≈ $1157.63
As you can see the compound interest has helped your investment grow to $1157.63 over the 3-year period. This is because the interest earned in each year is added to the principal and contributes to the calculation of interest in subsequent years.
Compound interest can be powerful in helping investments grow over time. It is commonly used in various financial products such as savings accounts certificates of deposit (CDs bonds and loans. By understanding and harnessing the power of compound interest individuals and businesses can make informed decisions and potentially maximize their returns or savings.