Sunday, April 19, 2009

STI: Er, what's compound interest?

April 19, 2009


Er, what's compound interest?


Where do you see this?


In financial articles.


What does it mean?


Compound interest differs from simple interest in that simple interest is calculated solely as a percentage of the principal sum.


Compound interest is the interest you earn not only on your initial principal but also on the interest accumulated over earlier periods.


For example, if you put $1,000 in your fixed deposit and it earns 5 per cent in interest a year, you'd have $1,050 at the end of the first year. At the end of the second year, you'd have $1,102.50.


After two years, you'd have earned $100 on the $1,000 you put in initially, plus $2.50 on the $50 worth of interest you earned in the first year.


Even if you do not add another cent to that account, in 10 years, you'd have $1,628 thanks to the power of compound interest. And in 25 years, you'd have $3,386.35.


Why is it important?


When you understand the power of compound interest, long-term investing makes a lot of sense because the amounts will add up rapidly over the years.


So you want to use the term. Just say...


'This acount is for the long term, to earn compound interest.'

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