Compound Interest

What is Compound Interest and How Does it Work?

Compound interest is interest calculated on the initial principal as well as the accumulated interest from previous periods. It allows your money to grow faster over time compared to simple interest.

Why is Compound Interest Important for Financial Planning?

Compound interest plays a crucial role in financial planning because it enables individuals to build substantial wealth over the long term. By starting to invest early and allowing investments to compound over time, individuals can take advantage of the power of compounding to achieve their financial goals, such as retirement savings or purchasing a home.

How to Calculate Compound Interest?

The formula for calculating compound interest is: [Tex]A  = P(1 + \frac{R}{100})^{n}[/Tex]

What Are the Benefits of Compound Interest Investments?

Compound interest investments offer several benefits, including:

• Faster growth of savings over time
• Increased wealth accumulation through reinvestment of earnings
• Diversification opportunities across various asset classes
• Potential for passive income generation through interest payments or dividends

Compound Interest: Compounding is a process of re-investing the earnings in your principal to get an exponential return as the next growth is on a bigger principal, following this process of adding earnings to the principal. In this passage of time, the principal will grow exponentially and produce unusual returns.

Sometimes we come across some statements like “one year interest for FD in the bank @ 11 % per annum.” or “Savings account with interest @ 8% per annum”.  When it comes to investment, there are usually two types of interests :

• Simple Interest
• Compound Interest

We already know about Simple Interest(S.I), we will look at Compound Interest(C.I) in detail in this article. First, let’s understand what is compounding through a story. 

A Prisoner was once awaiting his death sentence when the king asked for his last wish.

The Prisoner demanded grain of rice (foolish demand right?) but added that the number of grain should be doubled after moving to every square till the last square of the Chess Board ( that is 1 on first, 2 on second, 4 on third, 8 on fourth, 16 on fifth and so on, till the 64th square).

The king thought that it is a very small demand and ordered his ministers to have that much amount of rice calculated and provided to the prisoner. The amount calculated was so big that the king lost his entire kingdom and was indebted to prisoner all of his life.

What the prisoner used was the idea of “Compounding“. Now, let’s define Compound Interest.