how does compound interest work.

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how does compound interest work.

In: Economics

12 Answers

Anonymous 0 Comments

You get interests on the interests you made.

For example :

You place 100$ in an account at a really good rate of 100%. By the end of the year your account should have 200$ in it, meaning you made 100$ interests.

The thing is, your account is now 200$, not 100$ anymore. So if you keep this account at 100% for another year, your new balance at the end of year 2 will not be 300$ (100$ interests) but 400$!! Because 100% of 200$ is 200$.

That means, during year 2 you made 2 seperate types of gains :

1) 100$ on what you invested (wich is called interest)
2) 100$ on your gains/interests of year 1(wich is called compound interest)

Compound interest on your personnal investments work the exact same way on smaller interests rates.

Anonymous 0 Comments

It’s important to realize that compounding interest can work against you just as easily…

All these examples are “You invest $100… you make $110” and so on.

Compounding interest is also what makes paying debt, specifically credit cards (18%), mortgages (~3-4%),and student loans) so difficult. Imagine you borrow $100, and pay back a share of it. But now, the $100 you borrowed is actually $118. And the next year it’s up to $139. If you didn’t pay back a substantial amount, the interest is going to be more than you pay back. And then next month/year, all you’re able to do is cover the interest.

A real life example – if you get a mortgage over 25 years, you’re paying MOSTLY interest for the first 10-12 years of your payments. Your principal (the amount you borrowed) is barely affected because the interest is so high (based on a 25 year payment plan). If you borrow, $500,000 – the compounding 3% interest will make that closer to $750,000 by the time you pay it off.

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!

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

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

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.