Compound Interest vs Simple Interest
Interest is the cost of borrowing funds from a bank/financial institution or the income gained from depositing funds in such an institution. There are two types of interest payments, which are simple interest and compound interest. Simple interest and compound interest are quite different because of the way that each is calculated, and the amount received through compound interest is always preferred to a depositor/investor as he/she can get a higher return than simple interest. The following article differentiates between the two with clear examples and outlines the differences and benefits of each form of interest.
What is Simple Interest?
As for simple interest the interest amount will be calculated only on the amount that was initially deposited, called the principle. Taking an example, I have $100 to invest and go to the bank ABC to do so. The bank offers me a simple interest rate of 10% per annum. At the end of the 1st year, I would have received 10% of $100, $10 – with a total of $110. At the end of the 2nd year, I would have received another 10% on my principle, $10 – making a total of $120. At the end of the 3rd year, I would make a total of $130.
The calculation of the simple interest would take a very long time for me to double my initially invested amount and may not look very attractive given the higher 10% interest rate.
What is Compound Interest?
Compound interest, on the other hand, is calculated, not on just the principle amount, but also on the interest that getting added on every year. Applying the same example, I go to another bank XYZ with my $100, and they agree to pay me compound interest of 10%. At the end of the 1st year, I would still receive only $10, making a total of $110. At the end of the 2nd year, I would receive 110*(1+10%) = $121. And by the end of the 3rd year, I would receive 121*(1+10%) = 133.1.
As can be seen, the interest that I am receiving through compound interest is much higher and gives a better return than the use of the simple interest formulae.
Simple Interest vs Compound Interest
Compound and simple interest are very different from each other in that simple interest gives a smaller return, and compound interest gives a much larger rate of return. In choosing between the two, for an interest to be received the selection of a compound interest paying account will be much beneficial to any investor.
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What is the difference between Simple Interest and Compound Interest? • Interest is the cost of borrowing funds from a bank/financial institution or the income gained from depositing funds in such an institution. There are two types of interest payments, which are simple interest and compound interest. • As for simple interest the interest amount will be calculated only on the amount that was initially deposited, called the principle. • Compound interest, on the other hand, is calculated, not on just the principle amount, but also on the interest that getting added on every year. • Compound and simple interest are very different from each other in that simple interest gives a smaller return, and compound interest gives a much larger rate of return.
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