Compound interest

Compound interest is the effect of adding the interest accrued in one period to the capital sum and then applying the interest rate in the next period to the new total capital sum and repeating the process for subsequent periods. Its easier to see in a practical example. If you start with $1,000 in your savings account and you earn 10 percent interest a year after the first year you would have $1,100 in your account. A year later you would earn another 10 percent but this time on $1,100 rather than just on the original $1,000 so at the end of the second year you would have $1,210. At the end of the third year you would have $1,331etc. In summary it builds rapidly. A good rule of thumb to remember is that an annual interest rate of 7.2 percent will double the principle sum after 10 years because of compound interest. Bringing that closer to the current reality, an annual interest rate of 3.6 percent will double the principle after 20 years with compound interest.

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