# What is the difference between compound interest and simple interest?

Published at 23rd-April,2020

Simple interest calculation method

Generally, simple interest will only use the "initial principal" as the basis for calculating interest. The calculation formula is as follows:

Sum of principal and interest = principal × interest rate × time

(Unless specifically emphasized, the above interest rates usually refer to the "annual interest rate")

In real life, although it can be divided into monthly, quarterly, semi-annual, and annual interest payments according to different products, it does not have much impact on the calculation of simple interest. For example:

Both product A and product B are 10,000 USD commodities with an interest rate of 12%.

However, product A pays interest once a month, and product B pays interest once a year.

§ The interest per period of product A is: 10,000×(12%/12) = 100 USD, monthly interest is 100 USD, and annual interest is 1,200 USD

§ The interest per period of product B is: 10,000×12% = 1,200 USD, and the annual interest is 1,200 USD

It can be seen that the total amount of interest for product A and product B is the same,

The only difference is that product A will receive part of the interest earlier and can be used for distribution as soon as possible.

Compound interest calculation method

Compound interest is based on the current "total capital" as the basis for calculating interest.

That is to say, the previously accumulated interest will also be included in the calculation of subsequent interest to achieve the so-called " money breeds money". The calculation formula is as follows:

Sum of principal and interest = principal × (1+interest rate per period) ^ number of periods (number of interest accruals)

(Interest rate per period = annual interest rate / number of interest accruals per year)

At this time, the difference in the monthly, quarterly, semi-annual, and one-year interest payments of the product will affect the "period interest rate" and "period number" in the compound interest calculation. For example:

For a product with an annual interest rate of 12%, in the case of monthly, quarterly, semi-annual, and one-year interest rates, the initial principal investment is 10,000 USD. The sum of principal and interest after one year is calculated as follows:

§ Annual interest: 10,000 × (1+12%)1 = 11,200

§ The interest is calculated in half a year: 10,000 × (1+12%/2)2 = 11,236

§ Quarterly interest: 10,000 × (1+12%/4)⁴ = 11,255

§ Monthly interest: 10,000 × (1+12%/12)12 = 11,268

The results of the four interest calculation methods are different. If the limit is one year, it can be seen that the more interest calculation times a year, the greater the result.

And if the number of years is extended to ten years, this situation will be more obvious:

§ Annual interest: 10,000 × (1+12%)1⁰ = 31,058

§ Interest calculated in half a year: 10,000 × (1+12%/2)2⁰ = 32,071

§ Quarterly interest: 10,000 × (1+12%/4)⁴⁰ = 32,620

§ Monthly interest: 10,000 × (1+12%/12)12⁰ = 33,003

§ (Simple interest calculation: 10,000 × 12% × 10 = 12,000-the profit from the compound interest effect is far better than the simple interest)

It can be seen that: "If the time is stretched, the plan with more interest accrues, the more the sum of capital and interest will be obtained in the end!"

Therefore, "compound interest effect + long-term accumulation" is the basic standard configuration, and its essence and power can be seen.

To describe the sum of principal and interest in one sentence: "Simple interest calculation is linear growth, compound interest calculation is exponential growth!"

Comparison of simple interest and compound interest: "Simple interest is linear growth, while compound interest is exponential growth."

Which investment products can create compound interest effects?

According to the current investment market, the following four products are ways to create compound interest effects (please leave a message to provide other subject matter...):

1. Bank interest

2. Savings insurance, such as whole life insurance, annuity insurance, pension insurance, etc., all fall into this category.

3. Regular fixed-amount fund

4. The annualized rate of return of the market ETF (stock)

5. Cryptocurrency second contract transaction