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Compound interest is a powerful force that can turn even small amounts of money into significant sums over time. It is a simple concept that can have a big impact on your financial future. In this article, we will explain how compound interest works and showcase its power using an example of a $100 investment that grows to $1,000 over a 6-month period.
Compound interest is the interest earned not only on the principal amount invested but also on the accumulated interest. This means that as interest is earned, it is added to the principal, and the interest earned on that new higher balance is then added on top. Over time, this can create a snowball effect, resulting in exponential growth of the investment.
To better understand the power of compound interest, let's take the example of a $100 investment made for six months at a 10% annual interest rate. The interest is compounded monthly, which means that the interest earned each month is added to the principal amount, and the interest is then calculated on the new higher balance.
Using an amortization table, we can see how the investment grows over time. An amortization table is a detailed breakdown of each payment or interest earned, including the amount of principal and interest paid, and the remaining balance of the loan or investment. Here is what the amortization table for our example looks like:
Starting Balance
Interest Earned
Principal Paid
Ending Balance
As you can see from the table, the investment starts with a principal amount of $100. In the first month, the interest earned is $0.83, and the principal paid is $10.02. This means that at the end of the first month, the new balance is $100.81.
In the second month, the interest earned is slightly higher at $0.84, and the principal paid is $10.03. The new balance at the end of the second month is $101.62. This pattern continues each month, with the interest earned increasing slightly each time as the balance grows.
After six months, the investment has grown to $105.09, which is more than ten times the original investment of $100. This shows the power of compound interest, and how even small amounts of money can grow significantly over time.
It is important to note that the example above assumes a fixed interest rate and a fixed investment term. In reality, interest rates can fluctuate, and investment terms can vary. Additionally, taxes and fees may also affect the final return on investment. However, the principle of compound interest remains the same and can be a powerful tool for growing your wealth.
In conclusion, compound interest is a simple but powerful concept that can help you grow your wealth over time. By investing even small amounts of money and allowing the interest to compound, you can achieve significant growth in your investment over time. The key is to start early and be consistent with your contributions. With patience
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