You are probably familiar with the basics of compound interest, which is simply interest that grows on itself. Interest payments are made once per year, or multiple times per year, both on the principal investment, as well as the accumulated interest. Compound interest builds over time, and can have a tremendous impact on your financial success. But, did you know that you can calculate compound interest for a specific time period?
Let’s say you have $6,000 to invest. You have an account that will give you 7% interest (I know, pipe dreams), and you want to keep that money invested for at least 5 years. The interest is paid monthly. How much money will you have at the end of 5 years?
Calculating Compound Interest:
A=Amount of Your Investment (in 5 years). You are solving for A.
P= Principal Investment ($6,000)
R=Interest Rate (7%)
T=Time in Years (5 years)
N=Number of times interest compounds per year (monthly = 12)
A=$6,000 (1 + 0.07 ÷ 12 ) 12 x 5
A=$6,000 (.089) 60 (raising to the 60th power)
(Ok, here’s where you need a calculator. Try this one, which specifically calculates compound interest.)
That’s an extra $2,505 in your bank account after 5 years. Not bad.
Compound interest can be found in various types of accounts, including savings, checking, CDs, money market accounts, mutual funds, and IRAs. Stocks don’t really earn compounding interest, but have a “compounding effect” if you re-invest dividends.