how does compound interest work.

Question

how does compound interest work.

In: Economics

Answer 1

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.