Understanding Compound Interest
Albert Einstein famously called compound interest the "eighth wonder of the world". Unlike simple interest, which is calculated only on the principal amount, compound interest is calculated on the principal plus the accumulated interest.
How the Formula Works
The standard formula for compound interest is:
A = P(1 + r/n)^(nt)
- A: The future value of the investment/loan.
- P: The principal investment amount.
- r: The annual interest rate (decimal).
- n: The number of times that interest is compounded per unit t.
- t: The time the money is invested or borrowed for.
Why It Matters
For investors, compounding is your best friend. A small sum invested early can grow into a fortune over decades purely due to the "snowball effect" of interest earning interest. For borrowers, however, it can be dangerous, as debt can swell rapidly if not paid off.