The Power of Compound Interest Explained Simply

What is interest

Interest is basically the cost you pay for borrowing money, or you earn interest by lending money to someone else.

Types of interest

There are two main types of interest: simple interest, and compound interest.

1. Simple interest is when you pay or earn interest (money) from your original amount of money, also referred to as principal.

P = Principal (the starting amount of money)
R = Rate of interest (per year, in %)
T = Time (in years)

For example, if you borrow $1,000 at 5% interest per year, in 3 year you pay:
SI = (1000 * 5 * 3) / 100 = 15000 / 100 = 150

You pay $150 in interest after 3 years.

Total = Principal + Interest = P + SI

In the example: 1000+150 =1150

So you will have $1,150 after 3 years.

2. Compound interest is, in simple words, interest on interest. Compound interest is when you earn or pay interest on both your principal and its interest that has been added over time. This method allows your money to grow faster because it is interest on interest.

You can calculate compound interest with the following formula:

A = Final amount
P = Starting principal

r = Annual interest rate (decimal)

n = Number of times interest is compounded per year

t = Time (years)

The longer you leave your money invested, the more powerful compound interest becomes.

Year	Start Amount	Interest Earned	Total
1	$1000	$50	$1050
2	$1050	$52.50	$1,102.50
3	$1,102.50	$55.13	$1,157.63

As you can see, the amount of interest earned increases per year without adding a new amount of money.

The Rule of 72

The rule of 72 is a formula which helps you estimate the time (in years) in which your original amount of money will double using the generated compound interest. The formula is:

For example, if you invest an amount with a compound interest rate of 6%, then your money will double in:

Years to double = 72/6 = 12 years

Your amount will double in 12 years.

By M. Nargis

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