Understanding Compound Interest
Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it.
Compound interest is the interest calculated on the initial principal, which also includes all of the accumulated interest from previous periods on a deposit or loan. It is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. This means that your money grows at an exponential rate over time, rather than a linear one.
The formula for compound interest is:
A = P (1 + r/n)^(nt)
Where:
- A = the future value of the investment/loan, including interest
- P = the principal investment amount (the initial deposit or loan amount)
- r = the annual interest rate (as a decimal)
- n = the number of times that interest is compounded per year
- t = the number of years the money is invested or borrowed for
Understanding how compound interest works is crucial for both investing and borrowing. For investors, it's a powerful tool for wealth accumulation. For borrowers, understanding compound interest highlights the true cost of debt, especially over longer periods.
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