Did you know that Albert Einstein declared compound interest to be the eighth wonder of the world in one of his speeches? Let us find out more about it. We’ll learn how to calculate compound interest and see examples of how it’s used in real life. Compound interest is defined as the interest that accrues when earnings for a specified period of time are added to the principal amount, increasing the principal base on which subsequent interest is calculated. Many students struggle with compound interest. In this article, We are going to know about compound interest, compound interest formula.
The concepts in this chapter can be easily grasped if learned online. Online math classes for topics such as it help students visualise problems and the solutions to them in a fun way. Cuemath is a website where you can take online math classes.
What is Simple Interest?
Simple Interest (S.I.) is a method of calculating the amount of interest for a given principal amount. Have you ever borrowed money from your siblings when you ran out of pocket money? Or perhaps lent him? What happens when you take out a loan? You put that money to use for the reason you borrowed it in the first place. After that, you return the money whenever your parents give you your next month’s pocket money. This is how borrowing and lending work in the real world.
However, in the real world, money cannot be borrowed for free. You are frequently required to borrow money from banks in the form of a loan. During payback, in addition to the loan amount, you pay some additional money based on the loan amount and the length of time you borrow. This is known as simple interest. This term is commonly used in banking.
What is the Difference Between Simple and Compound Interest?
Interest is the cost of borrowing money, and the borrower pays a fee to the lender in exchange for the loan.
In most cases, simple interest paid or received over a set period of time is a fixed percentage of the principal amount borrowed or lent.
Borrowers must pay interest on interest as well as principal because compound interest accrues and is added to previous periods’ accumulated interest.
Simple Interest Formula
SI = P*R*T/100 is the formula for simple interest (SI).
(A) = P+SI is the formula for calculating the amount (A).
It has a plethora of life-changing applications. Albert Einstein once said that the person who understands it earns it, while the person who does not pays it. Let us now go over the various applications of it in greater detail.
Aids in the Making of Investment Decisions – Compound interest aids in the decision-making process when it comes to investments. It is critical for all of us to invest in assets that will generate cash flows in the future. But how will you know if those investments are profitable for you? We compare the present value of cash outflows and the present value of cash inflows when making investment decisions. If the present value of cash inflows exceeds the present value of cash outflows, the decision should favour investment.
The Benefits and Drawbacks of Compound Interest
When you look at some real-life compound interest examples, you’ll notice that the concept of compound interest is appealing only when you’re on the earning side of the financial equation. Deposits are typically paid compounded interest by banks. As a result, if you’re depositing money, this is advantageous to you.
If, on the other hand, you have a credit card, knowing how compound interest works may be an incentive to pay off your balances quickly. Credit card companies charge interest on both the principal and the interest accumulated. Compound interest calculations reset your initial principal to include previously earned interest, so if you delay paying off your credit card debt, your principal will grow.