The Power of Compounding
Kelly, Leanna. “Simple interest vs compound interest comparison”, Investmentu, 18 Jun 2021, https://investmentu.com/simple-interest-vs-compound-interest/. Accessed 5 Sep 2021.
If you want your money to work for you and grow by itself constantly and efficiently, then compound interest is an important concept to understand. In this lesson, we will cover the basics of how compounding works and how to use it to your advantage.
What is Compound Interest?
Compound interest is where an interest rate is applied to a sum of money as it grows, building on itself at the same interest rate but applied to the growing sum of money. Compared to simple interest, which applies its interest rates on the original sum instead of the current sum, compound interest grows exponentially faster. While simple interest grows in a straight line, compound interest increases at a rapid rate that outgrows simple interest more and more over time. Simple right?
How do We Calculate Compound Interest?
The frequency of compounding is how frequent the interest rate on a sum of money is calculated. This is what controls the rate at which the sum grows, which means the more frequently a sum is compounded, the more it will grow in the same amount of time. If the interest rate is compounded annually, it will grow slower than if it is compounded monthly.
The formula for calculating compound interest looks like this: A=P(1+r/n)^nt A is the final amount, P is the initial balance, r is the interest rate, n is the compound frequency, and t is the number of compound periods elapsed.
How to Take Advantage of Compound Interest
We can take advantage of the concept of compound interest by consistently investing. If you start a savings account and consistently put in money each month, it will grow mind-blowingly faster than if you just put all the money in at the end of the year. The sooner you invest money, the more significant the returns will be. Compound interest is all about having your money build on itself.
Conclusion
See? Easy to understand right? Compound interest is a simple concept which can be applied in many many real life scenarios. By taking advantage of the power of compounding, a lot can be done with just a small amount of money to start out, which makes learning about the ways it is used in real life all the more important.
Dig in further
Here are some helpful videos that can help your understanding of compound interest.
Want a short video to explain the concepts? Click here
Want an example of how powerful compounding is? Watch this great video by Graham Stephan