Today I will share with you the difference between
simple interest and compound interest
and the power of compounding in long-term investments
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There are 2 types of interest rates
Simple interest and compound interest
Simple interest calculation is very simple,
Principal * Interest rate * time = Interest
Let's say you invest $ 20,000 in an account that pays 7% simple interest over 5 years
then you get $ 20,000 * 0.07 * 5 = $ 7000 interest
When calculating simple interest, your equity each year remains at $ 20,000
For the first year, take $ 20,000 * 0.07 = $ 1400
In the 2nd year, they also take $ 20,000 * 0.07 = $ 1400
and they do so for 5 years
then you just take $ 1400 * 5 = $ 7000 interest
Compound interest is a little bit more complicated
When they calculate compound interest, we have to ask
if the interest is compounded annually, monthly, or daily
Because this will yield different amounts of interest
Here, I only do an example when the interest is compounded annually
For example, you invest $ 20,000 in an account that pays 7% compound interest annually and invested for 5 years
The first year, your capital is $ 20,000
Interest for the first year is $ 20,000 * 0.07 = $ 1400
By the second year, your capital is no longer $ 20,000
which is $ 20,000 + $ 1400 = $ 21,400
Second year interest would be $ 21,400 * 0.07 = $ 1498
In year 3, it will be $ 22,898 * 0.07 = 1602.86
And 4th year, it would be $ 24,500.86 * 0.07 = $ 1,715.06
And for the 5th year, it will be $ 26,215.92 * 0.07 = $ 1835.11
And after 5 years, your total interest is $ 8,051.03
You can see,
same amount of capital, same interest rate, and at the same time
But the difference between simple interest and compound interest is over $1000
Let me do another example
For example, you start investing now
And every year you contribute $6000 into your investment account
and this account pays 7% interest
then after 20 years, you will have $ 286,409
After 30 years, you will have $ 652,111
And after 40 years, you'll have over 1.3 millions
And if you invest this money in your Roth IRA account
Your interest will be completely tax free.
Do you see the tremendous power of the compound interest?
Same amount, same interest rate
The only difference is time.
This compound interest takes time to grow.
The longer the time, the stronger the growth
So you have to start investing as soon as possible
If you do not have an investment account yet
then I recommend that you start with IRA accounts
It could be Traditional IRA or Roth IRA
But you have to start with IRA accounts first
because these accounts have huge tax benefits
I have made many videos about IRA, I will leave the link above
If you want to see more, you can click on it
Hopefully this video will help you better understand the difference between simple interest and compound interest
and see the power of the compound interest
to get more incentive to start investing
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