Introduction: Simple vs Compound Interest
When you put money in a bank, the bank pays you interest , a reward for letting them use your money. But not all interest works the same way.
Simple Interest: Interest calculated as a fixed percentage of the original principal every period. The amount earned each period never changes.
Compound Interest: Interest calculated as a percentage of the current balance every period. Because the balance grows, so does the interest earned , you earn interest on your interest.
This distinction might seem minor, but over long time periods it makes an enormous difference.
Deposit \5000$ into two accounts, both offering 5% annual interest. Account A uses simple interest, Account B uses compound interest.
Account A (simple): Earns 0.05 \times 5000 = \250$ every year, regardless of the current balance.
Account B (compound): Balance is multiplied by every year.
After 50 years:
- Account A: 5000 + 50 \times 250 = \17{,}500$
- Account B: 5000 \times (1.05)^{50} \approx \57{,}337$
Compound interest produces more than three times the wealth of simple interest over the same period!
Think of simple interest like earning a fixed weekly wage , you always get the same amount. Compound interest is like getting a raise every week based on your current salary. The richer you get, the bigger the raise , and it snowballs fast.