Piyush Gupta 12 Oct, 2024
Compound interest is a method of calculating interest where the interest earned on an investment or loan is added back to the principal (the original amount), so that the interest in the next period is calculated on the new total. This results in interest being earned on both the original principal and the accumulated interest from previous periods, leading to exponential growth over time.
The formula for compound interest is:
A=P(1+rn)ntA = P \left(1 + \frac{r}{n}\right)^{nt}A=P(1+nr)nt
Where:
Suppose you invest $1,000 at an annual interest rate of 5%, compounded monthly, for 3 years.
The calculation would be:
A=1000(1+0.0512)12×3=1000(1+0.004167)36≈1000×1.1616≈1161.62A = 1000 \left(1 + \frac{0.05}{12}\right)^{12 \times 3} = 1000 \left(1 + 0.004167\right)^{36} \approx 1000 \times 1.1616 \approx 1161.62A=1000(1+120.05)12×3=1000(1+0.004167)36≈1000×1.1616≈1161.62
After 3 years, the investment would grow to approximately $1,161.62, meaning you've earned $161.62 in interest.
Compound interest is powerful because it accelerates the growth of an investment over time, making it a critical concept in saving and investing strategies.
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