It is important to know the Pros and Cons of Compound Interest, as it is used in banks and for other financial purposes. Read on to know more!
There are basically two options for computing interest: simple and compound. Simple interest simply refers to an annual percentage of the principal.
The most common types of compounding on a daily basis are savings accounts, money market accounts, and even continuous compounding, in which the principal is continuously increased by compounded interest. In this article, we will tell you about the applications, calculations, and Pros and Cons of Compound Interest.
Applications of Compound Interest
The ways compound interest is used are as follows
1. Contribute money to an account
Compound interest can be earned on deposits made into savings or investment accounts, such as money market accounts, zero-coupon bonds, or high-yield savings accounts. Investing in stocks that provide dividends will also accrue compound interest.
2. Interest produced from the deposit.
The account will generate interest, which is frequently accumulated annually. For instance, if you put ₹1,000 into a savings account with annual compounding and a 5% APY, your balance at the end of the first year will be ₹1,050.
3. Compounding occurs with the initial interest.
Interest is earned by the APY on both the principal and interest amounts from the first year. The total interest would be ₹52.50 based on the prior example. The entire sum will reach ₹1,102.50 by the conclusion of the second year.
How compound interest is calculated?
- When calculating compound interest, you multiply the interest rate or rate of return you’re using by an exponential growth factor. In order to determine compound interest over a specific time frame,
A= P(1 + r/n)n
Where,
A = the final amount;
P = the principal
r= the interest rate expressed as a decimal
n= the compounding frequency;
t = time period in years.
2. Calculator for compound interest: Many calculators, both computer programs and portable ones offer exponent functions that can be used to determine compound interest rates.
Additionally, there are free online calculators. Vakilsearch has an online Compound interest calculator that can make the entire calculation process easy for you and save your time. Go to the website of Vakilsearch and enter details about the principal amount along with the rate of interest and time period. This online calculator will calculate the compound interest for you.
3. Spreadsheets: Investors can compute compound interest using spreadsheet apps that often provide a future value calculation function. Future value, which determines the future worth of the main investment based on accrued interest and interest payments, is the monetary value of an amount at a later time.
4. The rule of 72: The rule of 72 is a straightforward calculation that tells you how many years it will take to double an investment by multiplying the annual interest rate by 72. An investment will double in about 14 years, for instance, if the rate of return is 5% (72/5 = 14.4).
Pros and Cons of Compound Interest
It is important to know the pros and cons of compound interest so that you can benefit from it.
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Pros of Compound Interest
When it comes to your investments, compounding may be a powerful asset and help you build wealth. Compound interest’s exponential growth is crucial for preventing wealth-eroding factors including rising living expenses, inflation, and declining buying power.
Compound interest can be reaped by investors in one of the simplest methods possible with mutual funds. Reinvesting dividends from a mutual fund results in the purchase of more shares of the fund. Compound interest continues to build up over time, and the cycle of buying more shares will keep the investment in the fund increasing in value.
Think about a mutual fund investment that you open with ₹5,000 and then add ₹2,400 every year. The investment will be worth ₹798,500 after 30 years at an average yearly return of 12%. Compound interest is the difference between the initial investment’s cash contribution and its real future worth. Compound interest is ₹721,500 in this case, which is the future total after making a commitment of ₹77,000, or a cumulative contribution of merely ₹200 each month, over a period of 30 years.
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Cons of Compound Interest
Compounding can operate against borrowers who have debts with extremely high interest rates, such as credit card debt, despite the mythical story that Albert Einstein called the eighth wonder of the world or man’s greatest creation. A ₹20,000 credit card load held at a monthly compound interest rate of 20% would accrue a total compound interest of ₹4,388 over the course of a year, or around ₹365 each month.
Compound interest is always determined in advance of a payment, not after it has been received. Your rate of return may drop and cost you money if you consistently pay interest but are either late or miss a payment.
If you took a loan from Bank and want to know the compound interest you will be paying you can use the calculator provided by Vakilsearch. The online calculator on Vakilsearch requires you to fill in the details such as the principal amount you borrowed, the time period for which you borrowed the money, and the rate of interest at which you borrowed the money.
Once you fill in all these details the calculator will give you the compound interest that you have to pay. This online calculator will make the calculation process easy and fast for you so that you don’t have to worry about calculating the compound interest calculation.
Conclusion
Compound interest’s long-term impact on savings and investments is real. It is an essential component of wealth accumulation because it grows your money considerably faster than simple interest. It also lessens the impact of inflation-related price increases because they are almost certain to be outpaced.
There are both pros and cons of compound interest. Compound interest is a blessing for young people in particular because they have the longest amount of time to save. Keep in mind that the number of compounding periods is just as significant when choosing your investments as the interest rate.
If you want to calculate the compound interest, you can use Vakilsearch. Our website has a Compound interest calculator. You have to enter the basic details such as the principal amount, time period, and Rate of interest to calculate the compound interest.
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