Ask An Adviser - What Is Compound Interest And Why Is It Good? (2)

Top answer provided by:

Imran Amjad

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Hi Harry,

I keep my content simple and straightforward for my clients to easily understand the concepts. 

In this case, the Compounding Interest is simply the interest earned on the principal amount and the interest earned.  Now let’s look at an example to understand it. 

A person invests $100,000 with 4%pa interest rate compounding annually.  At the end of the first year there will be $104,000 with the 4% interest rate.  In the second year the 4% earning will be on $104,000 resulting in the principal and interest at $108,160. 

To delve more into the concept and making it clear to understand, one must understand that market-based investments aren’t guaranteed to return a flat or same rate of return.  Secondly, the duration of the compounding does play a significant role in getting a better outcome. 

Using some of the online calculators, (google search), would show that compounding interest on a monthly basis vs yearly for the same interest rate does provide a significantly better outcome especially if there was a regular investment made to the initial amount. 

For example, when investing $100,000 for a year with an additional amount of $1,000 per month to the total in a compounding interest investment, the total after a year would be $116,297.  The interest earned on the interest on much shorter intervals results in a higher outcome. 

As I mentioned above, the concept is not a complex one, hence my response is short and with a couple of examples. I would encourage you to use online calculators or visit Moneysmart for further information. You can also reach me via my Adviser Ratings page. 

Imran Amjad

While the Adviser Ratings Website facilitates the question and answer functionality, all such communications are between users and authorised financial advisers, of which Adviser Ratings has no affiliation. Adviser Ratings is not the advice provider and does not provide financial product advice and only provides information that is general in nature.

Article by:

Imran Amjad

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