What Is Compound Interest?
Compound interest is the interest on savings calculated on both the initial principal and the interest accumulated from previous periods.
For example, if you make a $1,000 initial investment into a savings account with a 5% interest rate, at the end of the first year that $1,000 investment would accumulate $50 in interest, for a total of $1,050. The next year, you’ll earn 5% interest on $1,050 which is $52.50. Each year, your interest will grow without having to make any additional contributions to your account.
Compound interest can apply to many different types of accounts, like Certificates of Deposit (CDs), bonds, or investment accounts.
How to Calculate Compound Interest
To calculate compounded interest you’ll use the formula: A = P(1 + r/n)^(nt)
P = Initial investment amount
r = Annual interest rate
n = Number of compounding periods per year
t = Time (in years)
Using this formula, you will be able to calculate the final amount your initial investment is worth after a certain number of years, considering compounding interest.
What Is the Rule of 72?
The rule of 72 is a simplified formula used to estimate the impact of compounding interest on your initial investment. The formula calculates how long it will take for an investment to double in value, based on an annual rate of return (interest rate, in this case).
To find out how many years it will take your investment to double, you can take 72 divided by your annual interest rate. For instance, if your savings account has an annual interest rate of 5%, you can divide 72 by 5 and assume it’ll take roughly 14.4 years to double your investment.
Rule of 72 Example
Let’s say you invest $5,000 into a high yield savings account with an annual interest rate of 4.3%. We’ll take 72 divided by 4.3 to get 16.74. We can assume it’ll take roughly 16.74 years to have $10,000 in your account if you don’t make any deposits or withdrawals within that time.
