how does compound interest work.

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how does compound interest work.

In: Economics

12 Answers

Anonymous 0 Comments

A cool math story I remember was if I give you $1 on the first day of the month, then $2 on the 2nd day, $4 on the third, $8 on the 4th, and I keep doubling that for 30 days, on the 30th day I’ll give you $1,073,741,824

Anonymous 0 Comments

The interest you gain are added each period thus the calculation (ex : 5% of x$ gets added to x$ for the next periods 5%) becomes exponential the more period you add.

Anonymous 0 Comments

ELI3: Let me hold some money for a while and you will get extra, then later extra **of the extra too**!

ELI5: Simple interest = a bit of what you gave me. Compound interest = a bit of what you gave me and a bit of that bit. For example: Let’s use 10% a month interest. Let me hold your $10 (so I can use it) and a month later if you want it back I’ll give you $11. If I get to hold it another month it’ll go up not by $1 to $12 but by even more! If you want it back then you can get $12.10. After 1 year you’ll have $31.38. The magic really increases over time, so that in 10 years you’ll have **$927,090.69**!

Anonymous 0 Comments

Compound interest is when you include the interest earned to the principle (initial money put in) when calculating future interest.

It’s a bit easier to understand with an example: say you put $100 in a bank account earning 20% interest, annually. After your first year you would have $120 ($100 x 1.2). Assuming you don’t take or add any money, after your second year you would then have $144 ($120 x 1.2)

Anonymous 0 Comments

You earn interest on the initial amount, but also on the previous period’s interest.

say you have $100 that gets 10% interest annually. At end of the year, you have $110 — $100+$10 interest. The next year, you’d earn the 10% on that $110, not just on the initial $100, so you earn $11 in interest.While it’s just a little difference early on, as the years go it, it starts to get much larger.

Anonymous 0 Comments

You have $100 that you deposit the bank at 5% interest. At the end of the month, the bank pays you $5 in interest. You now have $105.

If you leave the $105 in the bank for another month, you’ll earn more interest because you have more money. So instead of $5 in interest, you’ll get $5.25

Next month you’ll get another $5.76, and the interest keeps going up.

Anonymous 0 Comments

I have $10. I invest $10 in an investment that will get me $11 back every month, or a 1% return.

However, if I just keep that $10 in the same investment I will get way more than that 1% return over time if I take the profits from the investment and invest that as well.

The first month I invest $10, I get back $11 for a profit of $1

The second month I invest $11 and get back $12.1 for a profit of $1.1

The third month I invest $12.1 and get back 13.31 for a profit of $1.21

Fast forward 10 years, and that $10 has become $27.07.

Anonymous 0 Comments

Its really pretty simple. You have a certain amount of money – known as the princple – and interest is calculated at a fixed rate over a fixed period of time (known as the compounding period). The interest payment is then added to the original principle, and this higher amount becomes the _new_ principle for future calculations.

So, in an example. I have $100 in principle that earns 10% interest every month, and it compounds monthly.

In month 0, I have $100 (my original deposit)

At the end of month 1, I get $10 in interest ($100 * 10%) and its added to my original $100, so now I have $110

At the end of month 2, I get $11 in interest ($110 * 10%) and its added to my previous $110, so now I have $121

At the end of month 3, I get $12.10 in interest ($121 * 10%) and it is added to my previous $121, so now I have $133.10

Etc.

Anonymous 0 Comments

Compound interest means that the interest is added to the balance, and next period’s interest is calculated off of the total balance, including the interest. Hence, it compounds.

$100 gaining 10% interest, compounding annually, grows like this:

End of year 1 – 10% of $100 which is $10, total balance is $110.

End of year 2 – 10% of $110 which is $11, total balance is $121.

End of year 3 – 10% of $121 which is $12.12, total balance is $133.12.

End of year 4 – 10% of $133.12 which is $13.31, total balance is $146.43

You see how each year the amount of interest goes up? It’s compounding – you’re getting interest on the interest.

Anonymous 0 Comments

Let’s look at both simple and compound interest.

Simple: the increase in percent is relative to the initial amount. So the interest added will always the same amount.

While in compound the interest is a percent of the the initial amount + the interest added so far. So the new intrest added is always increasing!