The topic to be
covered in the post is POWER OF
COMPOUNDING. We all came across the term compounding either in school,
college, or in other areas. Many would have thought why it is needed or
stressed in back old golden days. Let me give a glance of term compounding with an example and tell its merits in a simple
understandable manner.
We all make use of compound words (a newly derived word from joining two completely
different words. Example hotdog came from hot + dog), the term compound interest is also similar to it.
Every time the interest is arrived not only on basic principle but also on the
interest earned in the previous period. In simple terms, compounding is the sum of reinvested interest along with principle
rather than paying out interest.
The formula used to
arrive at the compounding interest is
p(1+r)n, p- principle, r- a rate of interest and n- number of years.
For instance let us
assume that a sum of RS.100 is invested in a bank at an annual compound
interest of 7% for 5 years.
Year 0 in the table is
the year in which initial investment is made, compounding effect begins in the
year 2 (principle and interest of year 1 is reinvested). In absence of
compounding the investment would earn even payout of RS.7 every year.
The biggest merit of compound interest is interest
on interest. Many investors use
the same strategy to increase their wealth. The idea of compounding can also be seen at
the business level. Whatever the profit earned is retained and circulated in the business to achieve dramatic growth. I hope you
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