Simple interest vs Compound interest

Simple interest vs Compound interest

In simple words, Simple interest is the amount of money that you gain by the end of a certain period with the interest rate that was decided. Let’s look at an example:

Joe gave the bank $1000 and the bank promised to give Joe 10% interest on his $1000 at the end of every year for 5 years. Now the 1st year the bank gave Joe 10% interest meaning $100, so Joe has $1100. The following four years the bank kept giving Joe 10% interest. At the end of the 5th year, Joe had $1500.

Compound interest is when interest is not calculated on a fixed amount but at the latest amount. The best way to explain Compound interest is through an example:

Joe heard that the bank had a compound saving scheme, so he decided to try it. Joe gave the bank $1000 and the bank promised to give 10% compound interest every year for the next 5 years. The 1st year Joe got 10% on the $1000 so he got $1100. Now the next year he got 10% on the $1100 which is $210 and now Joe has $1210. In the 3rd year, he got 10% on $1210 which is $331. Like this, at the end of the 5th year, Joe had a whopping $1610.

In 5 years, Compound interest made Joe $110 more than the Simple interest scheme. Therefore, we can conclude that Compound interest is truly better than Simple interest.

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