Compound interest is one of the most powerful “weapons” in the field of finance, It can, however, be a “double-edged sword”. In fact, mathematician Albert Einstein argued that Compound interest It’s the eighth wonder of the world Whoever understands it benefits and whoever doesn’t understand it pays for it.
This is because using Compound interest can allow us in our favor make big profits, Whereas, if we have something against us, for example, when we refinance a loan, we can repay it by repaying Big amount
Compound interest allows us to get large sums of money over time
What is written interest?
we can define Compound interest such as one. created by the appointment of Capital What earns interest And then these interests generate new ones.
In simple terms, we can say that Capital earns fixed interestbut when he renewal It does this for both the principal and the interest we generate.
To clarify the concept, we can see it in an example. If we have $100 and invest it in an instrument that pays 10% per month, we will get $110 per month, which is basically $100 in principal and $10 in interest. If we decide to upgrade the totalNext month we will receive $10 corresponding to $121, $100, of the initial capital interest $11 for the first month and this second month.
as we can see, the second month we received more interest that even if in the first Interest rate remains the same: ten%.
This is because the interest generated was not on $100, but on $110. That is, we earned $10 in interest on the original $100, but we also earned $1 in interest on the $10 in interest we earned last month.
Compound interest generates interest on interest, creating a “snowball” effect in which more and more money is generated.
it is Compound interest ends generating that the real rate reached in one year is very high this rate nominal interest.
the same thing happens with Ready: As we accumulate debt, we generate interests on the interest generated very high rateto have an impact “Snowball” Which makes it hard to get out sometimes.
What is compound interest and how is it calculated?
As we mentioned in the previous paragraph, Compound interest the one who is born on interests who were born before,
For calculate it There are different ways, although the easiest is compound interest calculator that can be found by browsing the internet.
Currently, on the Internet, it is quite easy to find compound interest calculators.
However, if we want manual calculation We can use the following formula:
The letter “CF” in this case stands for “capital final», ie the capital that we will receive at the end of the period. On the other hand, the letter “CI” is starting capital Then, in the case of “i”, it is interest we get and at the end “n” is Condition Hey number of periods that we will place Pennies.
How to understand compound interest?
for understanding Compound interest We need to understand its characteristics. First, what is special Compound interest This is starting capital It increases each period as interest is added and this increases.
another one, interests are shaped Increasing Why? Interest accrues on capital that changes over timethat’s it Increases per additional units of currency added,
ultimately interest increases In each period, so the longer the period, the more interest we generate.
On the other hand, we must understand that although it can be applied in our favor make profit It can also work against us in case of debt, for which we must always try to pay our obligations on time.
It must be remembered that for Compound interest with In force we need to update the operation total, Going back to the $100 example, we can’t just rollover $100, but $110, because if we do it for $100, we won’t get the $10 interest we generate and so, c ‘Is simple. interest will be.
Simple and compound interest: example of each
we can define simple interest By way of profit or interest that a . is obtained by placing pennies for a certain period. interests Those which accumulate in each period are equal to those of the preceding periods, because the capital is constant, ie it does not vary.
In these cases, take capital to invest and multiply it interest. The interest by which it is multiplied is the interest for the period to be invested. For example, let’s say we have $100 and it earns us 5% monthly interest and we plan to invest our money for a year.
In this case, we take 5% and multiply it by 12, giving us a total of 60%. In this example, let’s take $100 of Capital And we multiply that by 60%, getting $160 after one year, $100 of initial capital and $60 of interests, From each month it will generate $5.
With a fixed mandate, we can obtain simple interest or compound interest if we renew the total
it is type of interest It is usually given in some functions long term of single capitalization or in cases where they are removed from time to time interests.
a clear example of simple interest and of Compound interest happens in fixed deadline. If we put $1,000 over a period of time with a nominal annual rate of 53%, we get $1,530 (if we withdraw the interest each month, that is, about $44 of the “profit” that we obtain).
However, if we choose Transfer principal and interest each month, the rate goes from 53% to 68%, i.e. an additional 15%. In this case, if we choose to withdraw the interest periodically, we will receive $1,680, or approximately $150 more.