Can someone explain to me the formula of compounding interest along with an example?

Question

Can someone explain to me the formula of compounding interest along with an example?

Answer 1

It's actually fairly simple. The amount you initially invest (the principal) earns interest, usually on a yearly basis. So, when you hear 10% per annum, that's what they usually mean: if you invest $100, you'll have a 10% interest at the end of the year, i.e, $10.

Compound interest is when the interest calculated is added to the principal, and then interest is calculated on the new total. For example, if you invested the same $100, and interest is compounded annually, then at the end of the first year, you earned $10 on $100, so you have $110 at the end of that year. At the end of the second year, the 10% is computed again, but this time, it's based on the new principal of $110, so this year, you earn $11. The third year, the interest is calculated on the new principal of $121, so you earn $12.10. And so on.

This is why compound interest is so powerful. If you invest a sum of money and it grows with compound interest, it can become a LOT of money at the end of 20 to 40 years.

Good luck,

FF

Answer 2

amount (1+r)^t

r=rate per period

t=number of periods

example 100 at 10% for one year

100(1+.10)^1=100x1.1=110

for 2 years

100(1+.10)^2=100x1.21=121