The Secret Behind Compound Interest

Simple interest can be computed easily by multiplying Principle amount, tenure, and Rate dividing it by 100. But to calculate compound interest, the principle amount, number of times the amount is compounded and interest value should be first considered, then the rate of interest should be converted into decimal, and the formula should be calculated as follows~:

The Secret of Compound Interest

What is compound interest?

Interest = {Principle (1+ Rate of Interest) ^ number of compounds.}-Principle

So, the person who is earning compound interest on deposits obviously earns more than the person earning simple interest. The rate of interest is uprightly lower because for simple interest, but compound interest is higher because a person earns interest more than once in the compounding year depending upon the scheme such as half-yearly, quarterly or yearly or even monthly.  Usually, the interest is compounded 5 to ten times in a year in most of the banks or financial institutions.

What is the meaning of compound interest?

The power of compound interest

If a person invests in any financial institution or trading that offers compound interest, then the growth of income is rapid. The power of compound interest can be explained with a simple example. For e.g. If 2 is multiplied by 4, it is equal to 8. But if 2 ^ 4, then 2 is multiplied 4 times and the amount attained is 16 which is double the amount when multiplied. To calculate compound interest, the interest is added to the principal and this amount is multiplied the number of times, the interest is calculated in a year and the total amount is deducted with the principal amount to determine the total interest.

The power of compound interest.

A person can witness steady growth in the savings on daily basis and this amount that is usually compounded more than 1 time in a year can even double after a certain period. But, one should be aware of the concept of compound interest thoroughly because one can earn drastically if invested at the right time. But suppose, if a person can borrowed loan from a financial institution that offers compound interest, then a higher rate of interest is paid on the loan every year. The forex traders, stock traders or the people invested in security usually enjoy compound interest. The compound interest may be calculated annually, half –yearly or quarterly and the interest that is accrued over a period of time, hence it depends on the frequency of calculation. The interest rate is higher if the interest is compounded frequently in a year.  

For compound interest, a person can earn interest upon initial investment and also upon the accumulated interest of previous compounding periods. To determine the compound rate, two factors are considered namely earnings on the reinvested income and time. So, the earning capacity of the investor increases every year.   

What does it mean to be calculated annually?

The annual rate is the rate of interest that is earned over a period of time on an investment after compounding. The annual rate of interest is a tool that is used to compare various investments at a given rate of interests that are compounded. Different people invest in different schemes with different interest rates that are compounded at different periods such as yearly, monthly, quarterly, or semi-annually. If person A has invested in a financial institution that offers a higher rate of interest, but may earn lower because the interest is compounded annually. But, a person may invest in a scheme that offers lower of interest but if the interest is calculated bi-annually, then the person may earn  higher because the interest is compounded twice in a year. So, the person can compare different types of schemes offered by various institutions and finally decide the amount to be invested to earn maximum profit.

What does it mean to be compounded annually?

Benefits of compound interest

A person can steadily earn higher income for a period by earning interest on reinvested amount. It is highly beneficial to retired people as they can steadily earn from their recurring deposit account.

To enjoy the benefits of earning more income within a shorter period of time, a person should invest as early as possible. For e.g. A person who has invested in a scheme that offers compound interest for just ten years at compound rate can earn even higher than the person who has invested for thirty years in savings. But a person should invest during his or her early period of career because they can invest more amount than they can invest at the end of their career.  

Even if a person earns 1% more than the interest earned over simple interest in a year, then that 1% extra interest would fetch ten percent more interest at the end of ten years.

A person should also consider the times the interest is compounded in a year. A person investing in a scheme that offers monthly compounding can earn the highest interest within a shorter time even if the interest is lower.

An investor needs not close account after a period of time and re-invest the same amount in other schemes such as dividends, stocks or mutual funds etc. But instead, the same amount can be renewed and the investor can earn accumulated interest along with the rate of interest on an initial investment.

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A person may earn more income by investing in dividends or stocks but is subjected to market risks. But, a person can earn steadily by investing in schemes that offer compound interest. This compound interest is usually offered by financial institutions whose financial condition is not affected by the market conditions. So, the investor does not experience any loss for investing in such schemes. A person can invest even during the recession period, but the rate of interest is lesser than the usual rate.

But an investor should be careful before investing and should access his or her financial condition because the money cannot be withdrawn easily from the savings account that offers simple interest.

If a person is investing for a long period can gain even higher income and can enjoy his or her retired life. A person investing between 9 years to 15 years can reap maximum benefits.  A person can become financially stable by just investing for few years.  The tax burden on interest is also relatively lower as the investor should pay only if the interest exceeds a specified limit. But the tax burden on dividends or gains from security investments is just higher.

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I am Swati basically from Belgaum. After completing schooling from St. Joseph convent school in Belgaum, I pursued with Commerce degree. After Commerce degree, I completed a diploma in export and import by correspondence and completed one year of M.Com from ICFAI. So, completing education, I worked in C.A firms and worked as an auditor in a KPO in Bangalore. I initially undertook freelance writing as a hobby and later on decided to undertake freelance writing as a full-time job. Nearly for ten years, I have worked as a freelance writer and even writing currently. I am married for eight years to a civil contractor from Belgaum and is blessed with a boy (4 years now).