How compound interest works: real-life examples

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investments, compound interest, reinvestment, investment process

The investment process can be approached in the standard way: to make a profit, return the invested amount and invest again, or not to change the amount of the originally invested funds. However, there is a way to increase profits.

What is compound interest

investments, compound interest, reinvestment, investment process

Under compound interest is considered to be the effect when the profit is added to the principal amount and participates in the creation of new profits in the future.

Compound interest is a concept that contains many meanings: it is the reinvestment of dividends, the addition of accrued interest to the Deposit amount, and the increase in investments of companies in their new projects at the expense of profits.

Now we are interested in what concerns investments in securities, currency and other assets circulating on the stock exchange. Therefore, we are most interested in the concept of "reinvestment".

Reinvestments can be divided by the object to which they are directed, on:

  • Real;
  • Financial.

Real reinvestments are investments of profit in real estate, equipment, etc. real assets. Financial reinvestment is the investment of profits in the stock market, binary options, PAMM-set, etc.

Rich people know the power of compound interest and long-term investments.

If you find an interesting profitable project, do not rush to withdraw money from it, let the compound interest do its job. So, the famous billionaire Warren Buffett never buys shares for less than 10 years.

Analysts have come to believe that any investor (even without a large amount of money) after six months of reinvesting profits can increase their capital by 5-15% only at the expense of compound interest.

Critics of reinvestment pay attention to the risks (the company will go bankrupt, the Manager will "merge the Deposit", etc.), they do not recommend "putting eggs in one basket", they advise to shift the freed funds to another asset or spend on themselves.

There is some truth in this – the stock markets periodically "storms", not all companies are stable, there are a lot of scammers around. However, this is not a reason to immediately panic and take profits as soon as it appeared.

Taking profits out of circulation just to hold on to them is sometimes very expensive. Often this leads to stomping in one place for many years. Although the investments themselves are successful, the investors withdraw the profits, which then quickly evaporate.

Reinvestment

investments, compound interest, reinvestment, investment process

Reinvestment refers to the re-investment of the profit already received from the asset, that is, the situation when the investor, having received a profit from the investment, does not take it away, but adds it to the previously invested funds to further increase income.

In banks, the process of reinvestment is called interest capitalization.

Reinvestments are divided:

  • Full-all profits are invested again;
  • Partial-part of the profit is invested in the asset, part is withdrawn.

How to calculate compound interest

To calculate, you need to take the initial amount, multiply it by the interest rate divided by 100, to the extent equal to the period for which the investment is made. The formula is as follows:

final amount = initial amount * (1+%) n

An example is a term Deposit in a Bank. In real life, when calculating compound interest, banks use a perfect formula, which has the form: the final amount is equal to the initial amount multiplied by one plus the interest rate divided by 100, multiplied by the number of days divided by the number of days in the year, raised to a power equal to the Deposit period. Thus, the formula is as follows:

final amount = initial amount * (1+p*d/y)n

Thus, if you invest 1 000 roubles under 10% annual, in a year you will have 1 100 RUB. If next year the contribution will be extended from 1 000 RUB., and from 1 100 rubles instead of 100 rubles you will get RUB 121 Think that's a little, but if you look at the future:

  • After 3 years-1 331.
  • After 4 years-1 464.
  • After 10 years-2,594.
  • In 20 years-6,727.
  • After 30 years-17 449.
  • After 40 years-45 259.
  • After 49 years-106,719.
  • After 50 years-117,391.

For clarity, you should compare the result of complex and simple percentages. Simple interest gives a linear increase in profits, reinvestment (compound interest) gives an exponential increase in capital, which gives a larger increase with a larger percentage, a larger term and a larger amount.

Thus, the larger the amount invested initially, the longer it lies on the Deposit and the higher the rate set for it, the faster and stronger it will increase, thereby accelerating the growth process even more.

What do simple and compound interest at the rate of 10% per annum for 20 years.

What do simple and compound interest at the rate of 10% per annum for 20 years
Year Simple interest method, RUB. Method of compound interest, RUB.
1 100 000 100 000
2 110 000 110 000
3 120 000 121 000
4 130 000 13 300
5 140 000 146 410
6 150 000 161 051
7 160 000 177 156
8 170 000 194 872
9 180 000 214 359
10 190 000 235 795
11 200 000 259 374
12 210 000 285 312
13 220 000 313 843
14 230 000 345 227
15 240 000 379 750
16 250 000 417 725
17 260 000 459 497
18 270 000 505 447
19 280 000 555 991
20 290 000 611 591

Important! For compound interest to reach its full potential, it takes time or a high interest rate, which is rare in low-risk projects.

Below is an example of how you can earn $1,000,000 over 11 years with a down payment of $3,000 at 50% per annum with a monthly top-up of $300 (i.e. $3,600 per year).

1 year $8,565

2 year $17,362

3 year $30,558

4 year $50,351

5 year $80,042

6 year $124,577

7 year $191,381

8 year $291 586

9 year $441,893

10 year $667 355

11 year $1 001 032

This example is described in more detail in the article about passive income, there you can find many ways of passive investments.

Quick million

investments, compound interest, reinvestment, investment process

Albert Einstein called compound interest the greatest invention of mankind. This is stated in many books on financial topics. These books like to give an example that if you put $1 on Deposit at 20% per annum with interest capitalization and daily Deposit another $1, then in 32 years you will have a million dollars

Important! Unfortunately, now only scammers offer 20% per annum. In Russia, banks offer only 2 – 3% per annum on deposits in foreign currency. Therefore, it will take more than 200 years for the strategy described above to work.

Compound interest is a powerful tool that, when set up correctly, creates money out of thin air. It's like a «magic typewriter». Compound interest can be used by everyone, whether savers or investors.

Reinvestment has both pros and cons. What to choose: withdraw profits or invest back, you decide. The only thing you should always remember is the purpose for which you invest. In addition, you should take full responsibility for your decisions and always think about them before you do something. We, in turn, will try to help you as much as possible in this not easy business – investments.

Any questions? Write them in the comments, our experts will answer you soon.

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