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Compound Interest

November 3, 2020 • 2 min read

Arguably speaking compound interest can be considered “interest on interest.”

The term “compound interest” refers to the total amount of interest calculated, not only on initial investment or loan but also on the accumulated interest obtained from previous years.

Compound interest can be calculated annually, quarterly, or monthly depending on the type of investment or loan provided by the financial institution. There are also two types of compound interest, namely periodic and continuous compound interest.

How do you calculate compound interest?

Compound interest is calculated using the following formula:

A = P (1 + r / m) mt

A: total value of the final investment

P: initial capital provided for the investment

r: the percentage investors will receive on their investment

m: the amount of time the investment is compounded (i.e. annually, quarterly, monthly)

t: the total amount of years, or months the investment will take to complete.

Here is a look at some real-world examples of compound interest at work.

Why is compound interest better?

Banks and fund managers will usually opt for investors to invest larger portions of money for longer periods as it offers better compound interest. Investors will usually see their initial investment growing faster as time progresses, allowing them to increase their wealth a lot quicker.

What are the types of compound interest?

Periodic Compound Interest: Investors will negotiate with financial institutions or fund managers on a decided interval at which the initial investment will receive interest. This can be monthly, quarterly, or annually.
Continuous Compound Interest: This is applied to initial investments with the smallest intervals possible, using the basic compound interest formula as previously discussed. This is the latter of the two, and most financial institutions won’t normally make use of continuous compound interest as a rule.

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