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# What Is Compound Interest? ## Definition of Compound Interest

• Compound interest is the interest on the initial principal as well as the interest from the prior periods.
• It is also referred to as interest on interest.
• With the same period of time, the sum of compound interest is always greater than simple interest because simple interest is the interest only on the initial value.
• If the money has not been withdrawn/ paid, the interest will increase over a period of time.

## What Impacts Compound Interest?

• The three things that impact compound interest are interest rates, the length of time you leave the money in the investment, and the frequency of the compounding.
• The higher the interest rate, the more you earn.
• The longer you leave your money to compound, the more money you will end up having in the future.
• The greater the number of times the money is compounded, the more you earn.
• For example, if your money is compounded every day, you would make more than you would if it was compounded every month.

## How To Calculate Compound Interest?

• Compound interest can be calculated by taking the total principal amount and interest rate in the future minus the present value.

Compound Interest = [P (1 + i)^n] – P

Compound Interest = P [(1 + i)^n – 1]

(Where P = principal, i = nominal annual interest rate in percentage terms, and n = number of compounding periods.)

## Compound Interest In Practice

• Using compound interest could be beneficial for depositors, investors, and lenders. But for borrowers, they would have to pay back more interest.
• For example, an initial principal is \$100, 10% compound interest rate annually.
• Year 1: \$100 x 0.1 = \$10
• Year 2: \$110 x 0.1 = \$21
• We can also use the formula:
• Year 10: P [(1 + i)^(n – 1)]
• \$100[(1 + 0.1)^(10 – 1)] = \$159.3745
• Note: It can only be used when there is no withdrawal/ payments made.