How Compound Interest works.

How does compound interest work? Business and compound interest go hand in hand, but which interest is better?

There are two different forms of interest that you can have through the banks: Simple Interest, and Compound Interest.

How it works

The difference between the two are small but are most certainly different. Generally, compound interest is often used in business transactions, investments and financial products intended to extend for multiple periods of years. Simple interest is mainly used for easy calculations: those generally for a single period or less than a year, though they also apply to open-ended situations such as credit card balances. (Investopedia, 2018)
In short, Compound Interest is the interest that the original investment (money put into the bank) earns, PLUS all of the interest earned on top of the interest that has already accumulated over time. The best way to describe Compound Interest is ‘Interest on Interest’. An easy way of looking at the difference between Simple and Compound

Interest can be seen below:
Simple Interest: the interest earned on the original investment only
Eg: $100 with 5% interest ($5 interest)
Year 1: 5% x $100 = $5
Year 2: 5% x $100 = $5
Year 3: 5% x $100 = $5
This equals $15 interest over 3 years

Whereas Compound Interest: the interest earned on the original investment plus all interests earned
previously
Eg: $100 with 5% interest compounded annually
Year 1: 5% x $100 = $5
Year 2: 5% x $105 = $5.25
Year 3: 5% x $110.25 = $5.5125
This equals $15.7625 interest over 3 years.
Why is compound interest better than simple interest?
This is simply because it earns you more money, and adds up to more profit in the long run.
If you’d like more information, send us an email and we’re more than happy to help you out.
answer any questions you may have about Compound Interest.

 

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