Throughout all our investment training you have surely heard the word “compound interest” multiple times. And of course, at first you may feel a little confused given that banks usually offer us interest on our deposits. Well, quite mediocre interests if we talk about banks... But what leaves us thinking is the word that accompanies it; "compound". So, if we put “interest” and “compound” together; What does this union produce? Let's look at the keys to compound interest, the topic we will address in today's investment training!
What is compound interest?路♂️
Let's start today's investment training by first defining what compound interest is. Compound interest is the interest calculated on the initial capital of our investment, which also includes all accumulated interest from previous operations. The interest that we have been generating is added to the initial capital and the interest already generated previously. In this way, we not only manage to make a profit on our initial capital, we also apply the previously generated interest to the initial capital to generate new interest. That is, the interest earned is accumulated to generate more interest.
Formulas for calculating simple interest and compound interest. Source: Let's talk about companies.
How is it different from simple interest?
It is usually mistakenly said that when a loan or deposit lasts more than one year, compound interest is applied. But that is not true, since the application of compound interest depends on the conditions we have agreed upon. First hand, simple interest does not apply the interest that has been generated, since it continues to generate the same profitability with the initial capital. On the other hand, compound interest allows us to reinvest the interest we generate to create a “snowball” effect with our investment.
Profitability of simple interest versus compound interest. Source: Medium.
How can we apply this to our investments?
Let's give an example to facilitate the understanding of this investment training. Let's say that I have an investment with an initial capital of 1.000 euros. They offer me 3% interest on my capital for 5 years. Let's see how it would look with simple interest and compound interest:
| Year | initial capital | Applied interest (3%) | Benefit when applying compound interest |
| 1 | 1.000 € | (1.000*3%)= €30 | 1.000+30= €1.030 |
| 2 | 1.030 € | (1.030*3%)= €30,9 | 1.030+30,9= €1.060,9 |
| 3 | 1.060,9 € | (1.060,9*3%)= €31,82 | 1.060,9+31,827= €1.092,72 |
| 4 | 1.092,72 € | (1.092,72*3%)= €32,78 | 1.092,72+32,78= €1.125,5 |
| 5 | 1.125,5 € | (1.125,5*3%)= €33,76 | 1.125,5+33,76= €1.159,26 |
Application of compound interest on an annual return of 3% on capital.As we can see, the annual interest that would be generated with simple interest would be €30, adding a total of €150 after 5 years. On the other hand, if we apply compound interest we generate €159,26. The difference that we can see in the example may seem small, although the application of this interest allows us to generate more profitability on our capital over time.
Conclusions from this investment training.
As we have been reviewing throughout this investment training, compound interest is one of the great advantages of investment, since it allows us investors to generate a return not only on our initial capital, but on the return we are going to make. generating. Thanks to the power of compound interest, we can maximize the profitability of our capital to make it grow at a greater rate. This is one of the solutions we have to capitalize our account and generate greater profits. Precisely the topic we discussed during the last installment of articles on investment training; We can now maximize profits with compound interest and at the same time opt for an account with considerable capital thanks to the funded accounts.