Compound Interest – “the eighth wonder of the world”

Definition: Interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. Compound interest can be thought of as “interest on interest,” and will make a deposit or loan grow at a faster rate than simple interest, which is interest calculated only on the principal amount.

The rate at which compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods (annual, 6monthly, quarterly, monthly or even daily), the greater the compound interest. Thus, the amount of compound interest accrued on Rs.100/- compounded at 10% annually will be lower than that on Rs.100/- compounded at 5% semi-annually over the same time period.

Compound interest is also known as compounding.

Compound interest can significantly boost investment returns over the long term. While a Rs.100,000/- deposit that receives 5% simple interest would earn Rs.50,000/- in interest over 10 years, compound interest of 5% on Rs.100,000/- would amount to Rs.62,889.46/- over the same period.

While the magic of compounding has led to the apocryphal story of Albert Einstein supposedly calling it the eighth wonder of the world and/or man’s greatest invention, compounding can also work against consumers who have loans that carry very high interest rates, such as credit-card debt. A credit-card balance of Rs.20,000/- carried at an interest rate of 20% (compounded monthly) would result in total compound interest of Rs.4,388/- over one year or about Rs.365/- per month.

Reference: Investopedia

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