We all know that the purpose of investment is to make money. The extra money you make on your investment is called Interest.
So today, let’s talk about the Interest on your investment.
Interest can either be simple or compound.
Simple interest is calculated using the following formula:
Simple Interest=P×r×nwhere:P=Principal amountr=Annual interest raten=Term of loan, in years
For example, if you invest $5,000 at a simple interest rate of 10%, for 30 years.
At the end of 30 years, you will have:
I = P X R X T = ($1,000 X 0.1 X 30) = $3,000
Your total balance = P + I = $4,000
Imagine that $3,000 in 30 years.
I don’t know about you, but that is not good enough for me.
Let’s check what the big brother – Compound interest can do for you.
Compound interest has been called the eighth wonder of the world because it not only lets your money works for you, but also ensures that the accumulated Interest you earn on your money works as hard. It lets you earn Interest on Interest, and if you understand and embrace this principle of reinvesting Interest, you will be able to build wealth quicker.
Let’s go with the same principal investment of $1,000, earning annual Interest of 10%, compounded annually. After 30 years, how much will you have?
Don’t worry….I have a formula for you.
Compound Interest=P × −P
r=Annual interest rate
t=Number of years interest is applied
Compound Interest = $1,000 X – $1,000
= $1,000 X 17.5 – ($1,000)
= $17,500 – $1,000
My knowledge of math tells me that, I’m getting a bigger bang for my buck on compound interest. What do you think?
Same amount invested, simple interest earns me $3,000 after 30 years. And my good friend, compound interest gave me more than five times that amount, $16,500.
I love math, so let’s play around with some other figures.
For example, if you invest $5,000 every year and generate a return of 10% on your investment per annum. In the first year, you investment will generate a return of $500. For some people, that is not a significant amount; they may choose to quit and look for another form of investment. They lost focus.
But for a consistent individual, if he continues with the $5,000 yearly investment, and provided that he is still getting the same rate, at the end of year two, the interest is not going to be $500, but $1,550. The power of compounding is showing up.
After five years, the balance in the account will be $33,578, that’s a total interest of $8,578 ($33,578-$25,000). I’m sure you are noticing the effects of staying focused and being consistent with your investment plan.
But wait, why on earth would you just do a one-time investment?
Let’s say you did not stop after the first year, but you continue to invest $5,000 every year for thirty years. Do you know how much you will have in your account after 30 years?
Give it a guess….
You will have $904,717. That’s almost a million dollar.