What is Compound Interest?
Compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. In simple terms, it's the interest on interest.
How It Works
The concept of compound interest revolves around the idea that money can grow at a faster rate than simple interest. When interest is added to the principal, both the original amount and the added interest earn interest in the next period. This can significantly increase the overall returns on savings or investments over time.
Formula
The formula for calculating compound interest is:
A = P (1 + r/n)^(nt)
Where:
- A = the amount of money accumulated after n years, including interest.
- P = principal amount (initial investment).
- r = annual interest rate (decimal).
- n = number of times that interest is compounded per unit t.
- t = time the money is invested for in years.
Benefits of Compound Interest
1. Accelerated Growth: The more frequently interest is compounded, the higher the total amount will be.
2. Long-term Gains: Starting to invest early allows you to benefit from exponential growth due to time.
Conclusion
Understanding compound interest is essential for making informed decisions about savings and investments. By ensuring your money works for you through compounding, you can achieve greater financial goals.