Compound interest is usually better than simple interest because it pays interest on the principal and the interest earned in each period. interest on the entire principal rather than the interest in each period. more, as it is matched by an employer's 401k contribution. more often throughout the year rather than once a year.

Question

Business

Nikolas Gilbert

27 August, 11:04

Compound interest is usually better than simple interest because it pays interest on the principal and the interest earned in each period. interest on the entire principal rather than the interest in each period. more, as it is matched by an employer's 401k contribution. more often throughout the year rather than once a year.

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Answers (1)

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Ana Kelly · Answer 1

Interest on the principal and the interest earned in each period.

Explanation:

By definition, compound interest refers to interest earning more interest by itself. It is easier to explain with an example:

you want invest $5,000 during 3 years, both banks offer the same interest rate = 5% yearly, but bank A offers compounded interest while bank B offers simple interest:

Bank A:

During the first year you earn $5,000 x 5% = $25.

During the second year you earn $25 + $1.25 ( = $25 x 5%) = $26.25.

During the third year you earn $25 + $2.56 ( = $51.25 x 5%) = $27.56

total interest earned = $25 + $26.25 + $27.56 = $78.81

Bank B:

During the first year you earn $5,000 x 5% = $25.

During the second year you earn $5,000 x 5% = $25.

During the third year you earn $5,000 x 5% = $25.

total interest earned = $25 + $25 + $25 = $75

The $3.81 difference is because with compound interest, the interest you earned in the previous year will start earning interest in the next year.