Recent Examples of compound interest from the Web
This is the one time when compounding interest can actually work against you.
Consider the power of compound interest via the 1626 purchase of Manhattan Island by Peter Minuit, director-general of New Netherland from the Man-a-hat tribe for an apparently ridiculously low sum of $24 in trinkets.
That’s the power of time. More specifically, that’s the power of time and compound interest.
Source: Social Security Administration WSJ: What about the power of compound interest?
Joseph Hargadon, the department head for accounting and information management at Widener, will teach about how to make financial decisions, including reducing debt and the benefits of compound interest.
Over time, the balance of the loan increases as a result of compounding interest and MIP, and fees, the CFPB wrote.
It has been estimated that the total cost to taxpayers will be $2.4 billion, due to compounding interest on bonds to build the facility.
The issue with this approach is that the investor loses out on much of the benefit of nearly two decades of compounding interest.
These example sentences are selected automatically from various online news sources to reflect current usage of the word 'compound interest.' Views expressed in the examples do not represent the opinion of Merriam-Webster or its editors. Send us feedback.
Financial Definition of COMPOUND INTEREST
How It Works
Let's assume you have $100 to open a savings account at XYZ Bank on January 1. The annual interest rate is 5%. How much will you have in five years?
Well, if the bank simply gave you 5% of your $100 at the end of the year, you would have $105 on December 31. If you left the $105 in the account to earn another 5% next year, at the end of that second year, you would have: $105 x 1.05 = $110.25. Not only did you earn interest on your original $100 in year two, you earned interest on year one's interest. That is, it compounded. If you carried this out another eight years, here's what your account might look like:
At the end of 10 years, you would have $162.89 in the account just for doing nothing. But it gets better. The example above assumes the bank pays interest on the balance at the end of the year (that is, the interest compounded annually). In the real world, a bank would usually pay you interest on your account balance at the end of every month (that is, the interest compounds monthly). The bank simply divides the annual interest rate (5% in our case) by 12 months, and applies that rate to your balance at the end of each month. So in year one, let's see what happens:
Notice that when the bank compounded the balance annually, you only had $105 at the end of year one. But if the bank compounds monthly, you have $105.12 at the end of year one. It may not sound like much, but consider the effect on a $500,000 beginning balance: At the end of 10 years, the investor has $814,447.13 if the interest compounds annually, but she has $823,504.75 -- a full $9,057.62 more -- if the interest compounds monthly.
It is important to note that compounding doesn't just affect how much interest investors earn; it affects how much interest investors pay. For example, if that $1,000 savings account had really been a $1,000 loan to you from XYZ Bank, the amount of interest you pay would be influenced by how often the bank compounded the rate. The important lesson here is that the more frequently compounding occurs, the more interest is earned (or paid) on a balance. Some credit cards even compound interest daily, which greatly affects the borrower's balance owed.
Why It Matters
The financial world often refers to compound interest as "magic" because it is one of the most fundamental ways to build wealth yet takes the least amount of effort. But because of the variety of interest calculation methods out there, borrowers should compare lender offers, and investors should compare investment offers by carefully reading the disclosure accompanying those offers. Investors are well served to understand how an institution’s choice of interest-calculation methods affect the amount of interest applied to the investor’s account. Depending on the anticipated activity, the borrower might save money and the investor might make more money by preferring one calculation method to another.
This InvestingAnswers story features a real-life example of how compounding can work for you: How One Normal Lady Turned $200 into $7 Million.
COMPOUND INTEREST Defined for English Language Learners
Definition of compound interest for English Language Learners
finance : interest paid both on the original amount of money and on the interest it has already earned
Learn More about compound interest
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