Compound interest is pretty dang awesome. It’s a powerful concept — one that can mightily strengthen, or weaken your finances. The man who understands it will have a tool to increase his net worth; the man who doesn’t will go through life stuck in a paycheck mentality.
The Power of Compound Interest shows how you can really put your money to work and watch it grow.
When you earn interest on savings, that interest then earns interest on itself and this amount is compounded monthly. The higher the interest, the more your money grows!
Compound interest is an extremely powerful force that allows investors to earn exponentially larger gains on their money over time — so, again, the money you save now is worth a lot more than the money you save later.
Compound interest can be defined as interest calculated on the initial principal and also on the accumulated interest of previous periods. Think of it as the cycle of earning “interest on interest” which can cause wealth to rapidly snowball.
Here’s what the compound interest formula looks like:
P (1 + r/n) (nt) – P
[P = Principal; r = annual interest rate in percentage terms; n = number of compounding periods for a year; t = number of years money is invested or borrowed]
Let’s take an example to understand this magical term
Let’s say you deposit an amount of Rs 10,000 at a simple interest rate of 5%. The duration of the deposit is four years.
Simple Interest earned will be equal to 10,000 x 0.05 x 4 which is equal to Rs 2000.
Compound Interest earned will be equal to
Rs 10,000 (1+.05/1)(1×4) – Rs 10,000 →
Rs 10,000 (1+.05/1)(4) – Rs 10,000 →
Rs 10,000 (1.21550625) – Rs 10,000 →
Rs 12,155.0625 – Rs 10,000 = Rs 2,155.06
Thus you get Rs 155.06 more if the money is deposited compounding annually.