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You only have so many hours in a day, let others make the money for you!” – Nick Haase, founder of Loot
The idea of interest may sound scary at first but when we look closer, we can see that it’s not so intimidating after all. We often hear the word ‘interest’ on advertisements about intimidating sounding home loans, car loans, and deposit accounts. But today, we don’t need loan application in understanding the concept of interest and how it can work for us.
Dear reader, an interest may help us earn through money working for us. We first need to define interest. Interest is additional cash we get when depositing money. In terms of loans, it is the cost of borrowing money. In the case of deposits, interest is the rate of additional money we get from the bank we deposited into. In the case of loans, we can describe interest as the rate of the additional fee we pay on top of the original amount of our loan.
For us to understand the interest more, we need to learn the difference between annual or simple interest versus compound interest. Simple interest is only based on the original amount of your deposit or loan, this is called principal amount. Through compound interest, you are earning interest not only on your principal but also on any interest you’ve earned in the past. The compound interest provides more earnings which allow your money to grow faster.
To help you understand better on compound interest, dear reader, we can look at below example:
In Year 1, we have deposited a principal amount of 1,000 Pesos in a bank. The bank provides 10% Interest rate. Using this, we would get an interest of 100 pesos for depositing our money. We then add this to our original Principal Amount (1,100 + 100 = 1,100). This sum is now our Total Deposit for Year 1.
In the next year (Year 2), assuming no withdrawals and additional deposits, we can use our Year 1 Total Deposit as our Principal Amount for Year 2. Using 1,100 as our principal amount and applying the 10% interest rate, we have another interest of 110. For Year 2, we have a Total Deposit of 1,210. For Year 3 til 10, we can apply an interest each year. As you can see from the table below, this is where we can clearly see the magic of compound interest. With letting our Year 1 deposit sit in the bank for 10 years and with a 10% interest rate, starting capital of 1000 Pesos garnered a total of 2,594. It is almost tripled our capital! All of this happened with just letting our money be deposited in the bank or invest in such interest-driven investments.
|Year||Principal Amount||Interest with 10% Interest Rate||Total Deposit (Principal Amount plus Interest)|
Our example tells the magic of compounding interest. Small deposits count and can still make a big difference over time. Thus, money can work for you over time. This discussion is a lesson to us all that the earlier we start to invest in our future, the more time we must make compound interest work for our benefit. Investing early helps us take advantage of compound interest. If we make additional contributions each year, compounding interest has a higher chance to provide more returns.
Disclaimer: We want to remind you, dear reader, that the content in this column is my opinion and AlphaEdge Research’s opinion only and should not be construed as investment advice because we’re not your financial adviser nor have we taken into consideration your personal objectives, financial situation, needs or circumstances as your fiduciary. This column is mainly for your entertainment and education only.