Compound Interest and Simple Interest Understanding Personal Finance Maths

  1. Importance of Personal Finance
    1. Personal finance: Why Is It Important?
    2. what is personal finance explained with example
    3. Compound Interest and Simple Interest Understanding Personal Finance Maths
    4. compounding effect Understanding Compounded Returns with Formulas and Examples
    5. value of money Exploring the Concept of Present and Future Value in Personal Finance
    6. Future Value of money Formula How to Calculate with Example
    7. Retirement Tips for How to Save, Plan, and Invest
    8. Inflation how it Impacts Your Retirement Income with formula and examples
    9. Diversifying Portfolio for a Secure Retirement example of Investing in Multiple Assets
    10. Retirement Corpus example Strategies and Assumptions for a Secure Future
    11. mutual funds introduction
    12. Asset Management Companies:Understanding Structure and Roles in Mutual Funds
    13. NAV Net Asset Value Understanding the Core Concept of Mutual Funds with example
    14. Net Asset Value in Mutual Funds Fair Division of Profits and Investor Returns
    15. Mutual Fund Fact Sheet A Comprehensive Guide Unlocking the Secrets of MF Factsheets
    16. types of mutual funds schemes as per SEBI October 2017 Circular
    17. MultiCap Funds
    18. Focused Funds
    19. Dividend yield funds
    20. ELSS Funds
    21. debt fund A Comprehensive Guide to Understanding What are Debt Funds in india
    22. liquid mutual fund
    23. Overnight Fund all you need to know about Overnight debt funds
    24. liquidity risk in mutual funds
    25. Banking and PSU Debt Fund
    26. Credit Risk Funds
    27. GILT Funds
    28. Bond Financial Meaning With Examples and 5 types of bonds explained
    29. YTM Yield to Maturity definition and how to calculate
    30. Accrued Interest Definition and Example how to calculate
    31. Active vs Passive Investing for Better Return
    32. What Are Arbitrage Funds? · ‎Example of Arbitrage Fund
    33. mutual fund terms top 10 jargons to know before investing
    34. CAGR how to calcullate Compound Annual Growth Rate with formula
    35. Rolling Return Analyzing Mutual Fund Performance Over Time
    36. Expense Ratio What Is this fee And Why Does It Matter with examples
    37. Direct vs Regular Mutual Fund
    38. Benchmark in Mutual What It Is, Types, and How to Use Them
    39. Mutual Fund Risk Exploring Beta, Alpha, and Standard Deviation
    40. sortino ratio and Capture Ratios uses in Evaluating Mutual Fund Performance and Risk
    41. Mutual Fund Portfolio Guide for Financial success
    42. How to choose the best Mutual Fund for Your Portfolio by Evaluating Risk and Objectives
    43. Mutual Fund for beginners cheat sheet for Financial Success
    44. Smart Beta etf Exploring the Factors that Drive Return
    45. Asset Allocation and Diversification to Build a Balanced Portfolio
    46. Investment Vehicles Exploring the Evolution From Mutual Funds to ETFs
    47. GDP to Market Cap Ratio: Exploring the Link between Macroeconomics and Investments
    48. personal finance guide for Long-Term Success by Taking Control of Your Finances
    49. Personal finance Guide to Optimizing Your Investments and Achieving Your Financial Goals
Marketopedia / Importance of Personal Finance / Compound Interest and Simple Interest Understanding Personal Finance Maths

Simple Interest

Understanding the maths behind personal finance is essential for mastering the subject. Once you have a handle on this idea, it will become increasingly easy to move forward with your financial knowledge.

This chapter aims to cover the most basic mathematics involved, particularly focusing on simple interests.

Let us take a look at an imaginary transaction:

Suppose a friend of yours is in need of money desperately and comes to you for assistance. Thinking of them as a friend, you are willing to give them the financial aid they require; nonetheless, being capitalists at heart, you furthermore expect compensation, or interest, on the sum you lend. It may sound strange to ask a buddy for remuneration; however, consider that it’s still valued assistance from your side – with no expense to your capital.

The transaction details are below:

Amount – Rs.100,000/-

Tenure – 5 years

Interest (%) – 10

 As it is evident, your buddy has agreed to reimburse Rs.100,000/- over a 5-year period and pay you an interest rate of 10%.

How much money will you have accumulated after 5 years? Let’s look into the specifics by doing the math.

Don’t forget the annual interest rate is applicable to the original sum.

The total amount of money being invested is Rs.100,000. This sum represents the principal value.

The interest rate is 10%

Yearly interest amount = 10% * 100,000

= Rs.10,000/-

This is the maths:

By applying the formula, you can obtain a total of Rs.50,000/- in interest.

Amount = Principal * Time * Return

Where the return is the interest percentage.

Amount = Rs.100,000 * 5 * 10%

= Rs.50,000/-

In the case of simple interest, only the outstanding amount of the principal is used to calculate interest.

Imagine a bank deposit. You put Rs.100,000/- in a Fixed Deposit, with an annual interest rate of 10%, for a term of 5 years. The resultant interest earned will be Rs.50,000/-. The calculations remain unchanged.

Banks don’t offer simple interest, they provide compound interest. Can you spot the difference between the two?

Compound interest

Compound interest is different from simple interest: the person or entity agreeing to pay compound interest is essentially being asked to add the sum of past interest rates onto the principal amount.

We can look at the same example mentioned earlier and see that the transaction details are as follows –

Amount – Rs.100,000/-

Tenure – 5 years

Interest (%) – 10

Interest type – Compound Interest (compounded annually)

Here’s the maths:

Year 1

At the end of your first year, you are entitled to 10% interest on the principal balance, including any prior interest. If you chose to finish at this point, you would get the starting capital with the interest applicable accruing to it.

Amount = Principal + (Principal * Interest),  this can be simplified to

= Principal * (1+ interest)

Here, (1 + interest) represents the interest portion; the principal is the original amount. With this in mind –

= 100,000 *(1+10%)

= 110,000

Year 2

Take a look at what would happen if you decided to close this in the second year, instead of the first; here’s how much you’d get back. 

You should receive not only the interest earned in the first year, but additional earnings from interest on that amount.

Principal *(1+ Interest) * (1+Interest)

Let’s simplify it further:

= Principal *(1+ Interest)^(2)

= 100,000*(1+10%)^(2)

= 121,000

Year 3

In the 3rd year, interest from the first two years would be included in the overall earnings. Let’s do some math:

Principal *(1+ interest) *(1+interest) *(1+interest)

The green section is the total receivable after two years, and the blue is the interest for year three.

We can make the above equation simpler.

= Principal *(1+ Interest)^(3)

= 100,000*(1+10%)^(3) 

= 133,100

This principle can be applied anywhere.

P*(1+R)^(n), where –

P = Principal

R = Interest rate

N = Tenure

So, if you were to have this open for the entire 5 years, you’d receive –

= 100,000*(1+10%)^(5)

=Rs.161,051/-

Compare the amount of Rs.50,000 earned from simple interest to the sum of Rs.61,051 gained from compound interest.

Compound interest and compounded return are powerful tools when it comes to managing your finances. Ultimately, all aspects of personal finance can be reduced to a single concept: compounding of money. It is worth investing extra time in comprehending this concept.

    captcha