![]() The investment value increases at faster pace in compounding. It can be clearly seen that at maturity the amount from compounding is higher than that from simple interest. If not repaid on time the interest burden keeps increasing. But in compounding the interest payment comes down as the principal is being repaid. The principal amount in simple interest remains constant, while in compound interest the principal amount keeps increasing as the interest from previous periods are added to it.Īlso, having a loan in simple interest ensures standard interest payments. The interest earned grows rapidly in compound interest and in simple interest it remains constant. The return from compounding is higher than that of simple interest. It is easy to calculate than compound interest. The simple interest amount remains same through the tenure of investment or loan. Simple interest is calculated with a simple formula which is Principal*interest rate*tenure. ![]() But in compounding this happens automatically with no extra effort needed. To earn interest on interest on has to immediately reinvest the interest earned. The basic difference between simple and compound interest is that the interest is not added to the principal in simple interest. But when it comes to investments one can earn more from compound interest. ![]() Having simple interest for loans is very easy as the interest payments are standard. Yearīy understanding the importance of compound interest and acting on it by investing in appropriate investments, one can achieve high returns. Therefore, the investment already includes all the previous interests. In compound interest one earns interest on interest. From the graph below we can clearly see how an investment of Rs 1,00,000 has grown in 5 years. P is principal, I is interest rate, n is number of compounding periods.Īn investment of Rs 1,00,000 for 5 years at 12% rate of return compounded annually is worth Rs 1,76,234. More interest accumulates over time through the continuous purchasing and the investment will grow in value.Ĭompound interest can be calculated with a simple formula.Ĭompound Interest = Total amount of Principal and Interest in future (or Future Value) less Principal amount at present (or Present Value) Opting to reinvest dividend or choosing a growth plan results in purchasing more shares of the fund. Investing in mutual funds is one of the easiest way of reaping the benefits of compounding. This way they can pay lesser interest than what they are liable to pay. Also, to take advantage of compounding one has to increase their frequency of loan payments. Also, if paying interest is ignored or any if there is any delay in paying the loan then the interest burden will surely be high. Your money keeps on multiplying over a period of time. The value of the investment keeps growing at a geometric rate (always increasing) than at an arithmetic rate (straight-line). This is because the interest of your invested money is also earning interest. He who understands it earns it and he who doesn’t pays it.” Compounding is a very powerful concept. A credit card loan is usually compounded monthly and a savings bank account is compounded daily.Īlbert Einstein rightly said “Compound interest is the 8th wonder of the world. ![]() The frequency of compounding depends on the instrument. The higher the frequency of compounding, the greater the amount of compound interest. Daily, weekly, monthly, quarterly, half-yearly and annually are the most common compounding frequencies. Frequency of compounding is basically the number of times the interest is calculated in a year. Compounding is done on loans, deposits and investments. When the principal includes the accumulated interest of the previous periods and interest is calculated on this then they say it’s compound interest. Compound interest in simple terms means interest on interest.
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