In the world of financial instruments, the most common types of interest formulations offered are simple and compound; the former offers a monetary benefit based on the principal amount of the investment while the latter pays interest earned upon accumulated interest. In mathematical terms, compound interest is a constant function with exponential and logarithmic properties.
The potential rate of return offered by compound interest financial instruments is often higher than those that offer simple interest, particularly when compounding is part of a long-term strategy that includes making frequent contributions to a fund or portfolio. The basic formula used to calculate compound interest is as follows:
A = P (1 + r/n)^(nt)
Although it is easier to use online compound interest calculators, all investors should be familiar with the formula because it can help you visualize investing goals and motivate you in terms of planning as well as execution. We start with A, which is your investment horizon or goal; in other words, the results of what you can achieve through the magic of compounding-
P is the principal balance of financial instruments, which can be certificates of deposit, bonds, savings accounts, and many others. The interest rate is defined by r; the n variable is the frequency of interest paid in a time period, and t is the number of time periods.
It is often said that Albert Einstein thought highly of the concept of compound interest strategies applied to savings and investing; there are a couple of quotes attributed to the famous physicist about compounding, but it is unlikely that he actually said them. What we know with certainty is that billionaire investor Warren Buffett has made compound interest the central aspect of his lifetime investing strategy, and it has truly worked wonders-