The Secret about

PRINCIPLE OF COMPOUND INTEREST

The word interest can be used in different contexts; it could be used to mean selfish, common, national, simple, and compound, bear in mind that the usage of the word interest is not limited to these words alone. What this post is concerned about is “compound interest”, how much do we know about it and how can we take advantage of the principle of compound interest. Many don’t understand how it works, some others don’t know the difference between the simple and compound interest. Justice will be done to this topic, hopefully, you will gain better insight into this topic.

Interest is a charge made for a loan or credit facility or a payment made by a bank or other financial institution for the use of money deposited in an account (Microsoft® Encarta® 2009.),  what this  means is that the extra money you pay/receive when you obtain a loan or make a deposit into an account is INTEREST. Nearly everyone is aware of this, but then interest can be subdivided into simple and compound interest.

Simple interest simply means that you earn a certain proportion of the initial amount that was either given out or received by you over a period of time, this initial amount is referred to as ‘principal’. Even if you leave the transaction the way it is, without making payment/withdrawal; the value of the interest accrued after the stipulated period doesn’t change while compound interest which was described as the “8th wonder of the world” by Albert Einstein means you earn interest on the principal and also on the previously earned interests within the period specified in the terms of the contract.

          “He who understands it earns it; he who doesn’t, pays it” -Albert Einstein

Why is compound interest a wonder?

The principle of compound interest allows money that has been invested to grow more quickly when it’s being earned and some people who don’t understand this principle can drown in debt if a loan is borrowed. 
Consider this table below: Initial amount deposited is ₦10,000 and the interest rate is assumed to be constant.


DURATION

AMOUNT+ R()

RETURN()

AMOUNT + R()

RETURNS()

1ST YEAR

10,800

800

10,800

800

2ND YEAR

11,600

800

11,664

864

3RD YEAR

12,400

800

12,597.12

933.12

 

What the table shows is that, when you make an investment with a fixed interest rate, in simple interest; the same amount gets added to the initial capital invested, but if the agreement carries compound interest, then even your interest gets interest. Don’t be confused, Robert Kiyosaki will say “the baby of your capital gives birth to a baby of bigger size who joins the initial family to give birth to a baby of even bigger size before you know it; you have a stash of money growing at a beautiful rate”.

Meanwhile if you notice that I emphasize investment rather than saving by bank deposit, it is because I believe your interest in this article is likely due to your urge to make more money; so think about it, how much can you make through your bank account? Even though most banks offer compound interests in the bid to encourage saving culture.

How can this principle hurt you?

Most people are quick to spot when the loan carries high-interest rate and escape from being the subject of a story that touches the heart, but for loan offerings that carry low-interest rate but with a clause of compound interest, it may end in dismay and stress. Even when the amount being offered is looking considerate and easily serviceable, it can grow rapidly with the principle of compound interest which can extend the period of the loan which will amount to pay more or in extreme cases, defaulting. It is important to pay attention to every detail when it comes to obtaining loans from financial firms.

          As much as you guide against the negative impact of compounding interest, you can also exploit it to gain wealth within a reasonable length of time; just as the likes of Warren Buffet and other rich humans have discovered within the course of history. Won’t you like to have a peek into the secret box of wealth? It awaits you in the concluding part of this post, hold that thought.