Compound interest is a term used mostly in the fields of finance and economics. The basic concept behind compound interest is that interest is added back to the principal. The interest rate is a specific percentage that remains fixed or permanent. There is also a specific time period for the rate to be in effect. For example, there can be a monthly interest rate as well as a yearly interest rate. The specific amount and time of the interest rate is outlined clearly. The principal within compound interest is the original amount of the loan, without the addition of interest. Interest is then added and accumulated to the principal over time. The process of adding interest to the principal is called compounding.
To examine how compound interest works, assume that you have $1,000 and you decide to put the money in the bank. There will be a 4% interest rate, which will be compounded annually. To figure out how much you will have at the end of the first year, you must multiply the principal ($1,000) and the interest (4%). Multiplying that will give you $40. The $40 represents how much money is earned from interest at the end of one year. Your total would then be $1,000 + $40 or $1,040.
At the end of the first year, you will have $1,040 in the bank. If you now multiply $1,040 and the 4% interest, you will get the amount to be added for the second year. The amount earned from interest is $41.6 which brings your total for the end of the second year to $1081.60. To find the total for the end of the third year, you simply repeat the process. By multiplying the principal $1081.60 and 4% for the interest rate, you get $43.26, the amount earned from interest. After adding $1081.60 and $43.26, you will get the amount $1,124.86. At the end of the third year, you will have a total of $1,124.86 in the bank. This is a $124.86 increase within three years.
No comments:
Post a Comment