Compound interest calculation: What is it and what is its usefulness in the economy?
Probably, when you have a financial or bank product or have some investment in the stock market, you have come across investors and bank agents who talk about the calculation of compound interest. To begin with, it is important that you know that interest is the cost of money; that is, when you ask for a mortgage or other credit, you must pay, in addition to the amount borrowed, a higher percentage due to the interest that is added for a certain period of time. This is called the interest rate, and there are two types of rates: simple and compound. Compound interest how to calculate
Simple interest simply means a fixed percentage of the principal each year. For example, if you invest $1,000 at 5% simple interest for 10 years, you can expect to receive $50 in interest each year during the next decade. No more, no less. In the world of investments, bonds are an example of a type of investment that normally pays simple interest. On the other hand, compound interest is what happens when you reinvest your profits, which then also generate interest.Compound interest essentially means interest over interest and is the reason why many investors are so successful. Compound interest how to calculate
What is compound interest?
Reinvesting compound interest makes more money. This means that this product helps to multiply the initial capital you have according to the interest rate they are managing and, thus, increase your profits at the end of a day. So, periodically adding this interest helps increase revenue.
Because of this, compound interest lets you reinvest your money at the end of each term, and the money you make from your investment can grow at a very fast rate.This is known as “continuous capitalization,” which consists of a formula that helps you know the present and future value of a certain amount of money, adding the corresponding interest that will be accumulated.Compound interest is added to the initial amount and re-invested to make extra money.
How do you calculate the compound interest?
To perform the compound interest calculation, this formula is used: Cn = C0(1+i)n, the “Cn” being the capital that results at the end, the “C0” being the amount you deposited to invest, the “i” being the interest rate, and the “n” being the period of time in the middle of which you will make the investment to, subsequently, receive the To apply this formula, you can use this example:
If you have an investment of 7,000 euros with an interest rate of 6% over a period of one year, your final profit would be €7.420, calculated in this way: First, you multiply the initial amount by the percentage of the interest rate (7,000 x 6%), and the final percentage would be €420. To this amount, you add the initial amount (7,000 + 420), and in the end, you would have to give €4,420. For the next year, your initial capital will be €7,420. That is, the initial capital from which you started earning the most interest.There, you are already capitalizing on the interest, and you will get a higher income from your investment.
Compound interest vs simple interest
The main difference between simple and compound interest is that interest is reinvested.Compound interest reinvested increases earnings.
Simple interest does not reinvested and always pays the same amount. In addition:
- Simple interest is the interest that cannot be capitalized. In other words, it does not affect the money you invest at the beginning. Compounding, on the other hand, adds interest to the capital, increasing the initial investment in the end.
- Simple interest always uses the initial capital.
The compound, however, increases the beginning money dependent on the final capital. - With simple interest, the profitability is much lower. But the return on compound interest is higher.
- With simple interest, the calculation is very simple and easy to understand. However, the calculation of compound interest is a little more complicated because it includes capitalization periods.
What factors affect the calculation of compound interest?
In order for the calculation of compound interest to be satisfactory, you must take into account some factors that influence the results you will obtain. These include the expected average annual return, initial capital, investment time, and regular investment. The first is your annual investment income, which you may compare to later years to see if you made a profit or loss. In other words, this shows the return you have achieved with your investment.
The initial capital, as its name says, is the amount you count on when you start your investment. It is the amount you expect to increase over the years thanks to your interest rate or investment. It is the amount you expect to increase over the years thanks to your interest rate. Another aspect for calculating compound interest is the time you plan to carry out your investment, and the number may vary depending on your needs. Finally, the regular investment is the one you frequently make when your period of time ends.
What is the purpose of calculating compound interest?
The main function of the compound interest calculation is to act as a multiplier, that is, to help your income gradually increase from time to time.Previous interests are added to new ones, which are added to future ones.
This starts a chain reaction that benefits you if you buy this product. In this way, this interest is a great option to be able to save in the long term and increase your capital.
Compound interest is an important concept for investors since it allows them to convert seemingly small amounts of money into large amounts over time. To make the most of the power of compound interest, investments must be allowed to grow and accumulate over prolonged periods.Look for a loan without capitalization if you wish to avoid extended, pricey debts.
Composite options are best for those who want to make a lot of money.
example of compound interest
You want to invest 100 euros for a year at an interest rate of 5%. Your capital increases after one year due to an interest rate of 5 euros. After 1 year: capital = €100 x 1.05 = 105.
Capital after 2 years: €105 x 1.05 = €110.25.
The €100 capital and €5 interest from the first year rose in the second year.
First compound interest: 25 cents after two years.
Compound interest is €5.25. To continue benefiting from the compound interest effect, you have to reinvest the interest of €10.25. If you do this for a total of ten years, your capital will grow. After the tenth year: capital = €100 x €1,05 10 = €163. Compound interest how to calculate
