How_Money_Works_-_The_Facts_Visually_Explained

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PERSONAL FINANCE

Debt

How it works

Interest is the cost of borrowing

money, for example from a bank,

and it is calculated as a percentage

of the capital. When money is

saved it is effectively being lent

to the institution, which then pays

interest to the investor, so the

capital “earns” interest.

With simple interest, money

is paid out to the investor each

year. Compound interest is interest

paid on reinvested simple interest,

and works for both saving and

borrowing. The interest from the

first year is added to the initial sum,

so in the second year interest is

paid on the capital plus the interest

accrued. In the third year it is paid

on the capital plus the first two

years’ interest, and so on.

$1,10 0

$1, 210

$1,331

$31 extra earned

through compound

interest

COMPOUND

INTEREST

= 10%

COMPOUND

INTEREST

= 10%

INTEREST

PAID = $110

INTEREST

PAID = $121

INTEREST
PAID = $100

CAPITAL GROWS

The third year now

begins with a balance

of $1,210, which

earns $121 in interest

(10 percent of $1,210),

resulting in an end of

year balance of $1,331.

IMPROVED GROWTH

Compound interest results

in a gain of $331, $31 more than

if simple interest had been

applied to the initial deposit at

the same rate of interest for the

same period, which would have

resulted in a gain of $300.

END OF

YEAR 2

END OF YEAR 3

“Compound interest is the

eighth wonder of the world.

He who understands it, earns

it; he who doesn’t, pays it.”

Albert Einstein

US_208-209_Interest_Compound_interest.indd 209 14/10/2016 13:07