What is Compound Interest?
Compound interest is a powerful concept in finance that allows your money to grow exponentially over time. It occurs when interest is not only calculated on the initial principal (the original amount of money), but also on the accumulated interest from previous periods. This compounding effect can significantly boost the overall growth of your investment or savings.
Here’s a basic overview of key concepts related to compound interest:
- Principal (P): This is the initial amount of money you invest or deposit.
- Interest Rate (r): The annual interest rate, expressed as a percentage, that is applied to the principal amount.
- Time (t): The number of periods (usually in years) for which the money is invested or borrowed.
- Compound Frequency (n): This represents how often the interest is compounded within a year. Common compounding frequencies include annually (n = 1), semi-annually (n = 2), quarterly (n = 4), monthly (n = 12), and daily (n = 365).
The compound interest formula is given by:
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 or loan amount).
- r is the annual interest rate (as a decimal).
- n is the number of times that interest is compounded per year.
- t is the time the money is invested or borrowed, in years.
Let’s break down an example:
Suppose you invest $1,000 at an annual interest rate of 5%, compounded annually (n = 1), and you plan to leave the money untouched for 3 years. The compound interest can be calculated as follows:
How To Use Compound Interest?
A – 1000(1+0.05/1)^1*3
A – 1000 * (1.05)^3
A – 1000 * 1.157625
A ≈ 1157.63
So, after 3 years, your investment would grow to approximately $1157.63.
Compound interest is a fundamental concept in the world of finance and investing, emphasizing the importance of time in wealth accumulation. The more frequently interest is compounded and the longer the money is invested, the greater the impact on the overall growth of the investment. Start investing http://dorianfinance.com/how-to-invest-in-the-stock-market
