![]() N = the number of compounding periods per unit of time P = principal (the initial deposit or loan amount) Whether it is interest you will earn or interest you will pay, compound interest can be calculated using the following formula: To gain better insight into how much compounding interest can affect what you earn or pay, take a look at how it’s calculated. You may end up paying more or needing more time to pay off your balance. When interest is charged on credit card accounts or loans that use compounding, that interest is calculated based on your principal plus any interest previously accrued on your account. In the case of money you borrow, compounding can work against you. When interest is based on your growing balance, your funds can snowball over time. ![]() If you were paid simple interest on the account above, you would earn the same $20 interest a year rather than reaping the rewards of compounding. Simple interest, on the other hand, is calculated on principal only. (Most banks compound interest much more frequently we chose annual compounding to simplify this example.) Assuming the bank compounds interest annually, you would earn $20.40 ($1,020 x. If you were to deposit $1,000 into an account with a 2% annual interest rate, you would earn $20 ($1,000 x. When you take out a loan or take on credit card debt, interest works the other way: You periodically pay the financial institution a percentage of your outstanding balance for the privilege of using their money.Ĭompound interest is interest calculated on an account’s principal plus any accumulated interest. You just need to start.When you deposit money into a savings, money market or other type of deposit account, you may earn interest - a percentage of the account balance paid to you periodically by the financial institution for allowing them to use your money. You don’t need to start with a huge amount of money. ![]() The secret is to start as soon as possible. The great thing is that just a moderate investment over a long period of time will set you up for your future. Really, you need at least 20 years of regular investment to begin to see significant financial rewards. The sooner you begin to save and invest, the longer compound interest has to work its magic and grow your wealth. But, by investing early, and allowing your money to grow through compound interest, you can double, treble or better the real amount you put away.Ĭompound interest needs one thing to become a key contributor to your wealth: time. As we’ve seen in my previous blogs, this figure can seem daunting. When planning for your future, you should always have a figure in mind for how much will you need to support yourself in your retirement. Thanks to compound interest, the amount of money this investment will have created for you is just shy of AED 1.9 million. The actual cost of your monthly AED 2,000 investment is AED 600,000 (AED 24,000 x 25 years). You invest well and earn 8% interest over a 25-year period. ![]() When you start to create regular savings and investing it, you begin to make serious money.įor example, you save and invest AED 2,000 per month or AED 24,000 per year. So at 5% interest, you can double your money in 16 years - pretty easy money for doing nothing. Using the above example, after 5 years you’d have AED 12,762, in 10 years you would have AED 16,288 and you would have doubled your money in 15 years. Your money is generating more money just off the interest. And that’s the beauty of compound interest. You are making interest on your interest year-on-year. Just by leaving your money in the account, you’ve made AED 1025. A moderate return.Īt the end of year 2, the 5% interest rate is calculated against the total figure in your account, AED 10,500. You have AED 10,000 in your savings account and the bank offers 5% interest per year.Īt the end of year 1, your balance will stand at 10,500 after the 5% interest rate is added. Compound interest gives savers the ability to seriously increase their wealth. But not as many people seem to grasp how interest can work in your favour. Nearly everyone has a pretty good idea what interest rates are: You borrow money, you pay interest, like a rental fee for borrowing money. ![]() High credit card interest, high rates when getting a loan - generally it’s not the most positive word when discussing finance. There’s always a lot of talk about interest and most of the time it’s pretty negative. ![]()
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