Compounding effect: Difference between revisions
imported>Brianlenoach@hotmail.co.uk (Add link.) |
imported>Doug Williamson (Improve calculations.) |
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Interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is: | Interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is: | ||
= ( 1.06 x 1.06 ) - 1 | = (1.06 x 1.06) - 1 | ||
= 12.36% for the two year period. | = 12.36% for the two year period. | ||
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= 12.36% - 12.00% | = 12.36% - 12.00% | ||
= 0.36% over the two year period ( = 6% x 6% ). | = 0.36% over the two year period (= 6% x 6%). | ||
Revision as of 20:35, 15 January 2016
The additional growth or additional interest, resulting from the compounding effects of - for example - interest on interest.
Another example is the compounding effect of growth on growth.
Example
Interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is:
= (1.06 x 1.06) - 1
= 12.36% for the two year period.
Without the additional interest on interest, the total interest would have been simply
6% per annum x 2 years
= 12.00%.
So the compounding effect of interest on interest here
= 12.36% - 12.00%
= 0.36% over the two year period (= 6% x 6%).
When both the number of periods and the rate of growth/interest are low, compounding effects are relatively small.
When either the number of periods or the rate of growth/interest - or both - are greater, compounding effects quickly become very much larger.
