Hey guys, Lets talk compounded interest. compounded interest is the interest an investor earns on his original investment plus all the interest earned on the interest that has accumulated over time, or in other words interest on interest.
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To better understand the concept of interest on interest lets start by comparing it to simple interest.
Simple interest is the interest earned on the original principal only. So if we take $10,000 and invest it with a simple interest of 5% a year. After the first year, we would earn $500. After the 2nd year, we would earn again $500 and after the third year, we earn again $500.
so all together after three years, we ended up earning $1,500 of interest to bring our investment to a total $11,500.00.
Now if we take $10,000 and invest it with a 5% yearly compounded interest after the first year, the interest we would earn is the same as simple interest $500. But now going to the second year we now take $10,500 instead of $10,000 and we now earn 5% interest on the $10,500 instead of the $10,000 which is the interest on interest.
Now the interest we earn is $525 instead of $500. Going to year 3 we now have $11,025 and we earn once again 5% interest on interest and that would be equal to $551.25.
So after 3 years of investing $10,000 in 5% yearly compounded interest we have accumulated $11,576.25 which is $76.25 more than what we made with the simple interest investment
Compounded interest is even more emphasized when you compound the interest on a monthly rather than a yearly basis.
If we take $10,000 investment and earn 5% interest on it but now the interest is again compound monthly. After the first year, we will earn an interest of $511.62. Now going to our second year now our initial investment is $10,511.62 with the same 5% interest and again for one year. Now the yearly interest amount that we earned is $537.81 and our total investment is now worth $11,049.81.
And now going to our third year our initial investment is 11,049.81 with the same 5% interest and again for one year.
Now the interest that we earned is $565.34 and our total investment worth 11,615.34
Look at the difference: With the same $10,000 original investment with a 5% simple interest after 3 years we would have a total of $11,500.00 vs with a 5% yearly compounded interest, we would have a total of $11,576.25. And if we take the same $10,000 original investment but now the 5% interest will be compounded monthly after 3 years we would have a total of 11,615.34 with a $565.34 of total interest earned.
By compounding the interest monthly We grew our investment by over 6.8% compared to the yearly compounding and by over 23% compared to the simple interest.
This is why compounded interest is often called a snowball effect it Allows your money to grow in an exponential rate and not a linear rate
Investors that understand and utilize this concept at an early age are way more likely to retire rich than investors who start using it at a later age. There is actually a greater effect on how much time you are allowing your investment to grow and compound the interest than to how much money you originally invested.
Its all about patience and investing in the long term
and it is not a shock why Albert Einstien called compound interest the eights wonder of the world and said that he who understands it earns it he who doesn't pay it.
This is why the best way to get a high return on your investments is to allow the interest and dividends you earn on investments to be reinvested back into your investment. That and always aim long term investments.
Legal disclaimer:
This communication is for information purposes only and is not and under no circumstances to be construed as an invitation to make an investment with STEVLOC Management Inc., nor shall it form the basis of, or be relied on in connection with, or act as an inducement to enter into, any contract or commitment whatsoever. Individuals who are considering making an investment in specific securities offering are reminded that they must not make any decision on the basis of information contained in this advertisement/promotion but, rather, only on the confidential offering memorandum relating to that particular securities offering. Always seek tax and investment advice from a professional. Rates of returns and calculations are examples and for demonstration purposes only, not a commitment of return.
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