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What is compound interest?
The history of compound interest goes back thousands of years, at least to Babylon, the traditional for Israel. What compounding means is the adding of accumulated interest back to the principal so that interest is earned on interest from that moment on (Wickipedia; the peoples dictionary). This is far different than simple interest, which means that the principle remains separate from the interest, which is paid to the creditor at various intervals, and so is not added to the principal amount. In other word, compound interest is when you put your money in a bank, you will normally receive interest. Interest is a percentage received on the invested amount for a period of (usually) a year.
Principal for compound interest:
For example, say you invest RM1000 in a bank for 5 years at 5.00% interest per annum...
As you can see, your balance at the end of 5 years, using compounding is RM1276.30. However, if the simple interest calculation is used, you would only receive RM1250.00 at the end of 5 years.
So basically, compounding allows the interest you receive at the end of each year to generate more interest for the following years of your investment period thus enhancing your total returns.
When the interest is compounded once a year:
A = P(1 + r)n
However, if you borrow for 5 years the formula will look like:
A = P(1 + r)5
This formula applies to both money invested and money borrowed.
Frequent Compounding of Interest:
What if interest is paid more frequently?
Examples of the formula:
Annually = P ? (1 + r) = (annual compounding)
Quarterly = P (1 + r /4)4 = (quarterly compounding)
Monthly = P (1 + r /12)12 = (monthly compounding)
P = the principal (the initial amount you borrow or deposit)
r = the annual rate of interest (percentage)
n = the number of years the amount is deposited or borrowed for.
A = the amount of money accumulated after n years, including interest.
Compound interest from Malaysian perspective.
This time I want to show a newslater I subscribe from the young Malaysian millionaire mr. Irfan Khairi. He tells about the power of "compound interest" when we had saving. Compound Interest is the most important tool that gives rich people in the world. The key is, can start saving as early as even a little, and discipline to keep the consistency.
What is interesting here is where we select our saving store to provide high returns, the next great compound interest would be more shown again. He mentioned about the stores that can provide returns of 12% per year is, I is not no other - a mutual fund or unit trust.
"Now in Pakistan, returns 12% is quite normal if you research the companies Mutual funds.
Please read newslater the power of compound interest to know.
The compound intereset is not how do people get rich easier but it is how to make sure people get rich. Wanted to know what way? Let me explain with a better viewer...
Imagine a baby when born, every day, his/her mother put RM1.00 to the fund for the baby, of dollars daily. Its a total of RM30 per month. Year, the amount to RM365. Continue into the reserve fund and when the baby was aged 40 years, the amount contained in the fund is RM14, 600.
Money saved is not growth. Perhaps the funds used to upgrade to a larger fund. But, let's face it ... RM14, 600 from the storage for 40 years is not a large amount.
Now, imagine if the money is stored in the storage unit yields of 12% per annum interest and RM1 in store every day since birth. Money should only RM14,600, now RM352, 943.18 after 40 years.
RM352, 943.18? Where it came from the RM338, 343?
This is the answer to the question of how to become rich for sure. Addition of RM338, 343 is coming from the compound (Compound Interest).
Compound Interest is the most important tool that gives rich people in the world. Elbert Einstein was question of the compund Interest. Answers given by him is very easy. He said the compound interest is "the greatest Invention of all time."
Of course my example of the baby in the not quite logical. How much is a mother can enter RM1 each day until the baby is 40 years of age. However, my example is to show that the small savings that we, if invested in the long run, it will be great!
I have contacts who know to take advantage of interest compounds. They are husband and wife simple. Husband's income is RM2,500. Wife income is RM2,500. They live modestly and not wasteful. So, to cover all expenses paid by husband-living homes, cars, food and drink and all the requirements for payment by the husband. Meanwhile, the wife of the store to pay the storage unit yields 12% (now in Pakistan, returns 12% is quite normal if you research the companies Mutual funds).
A couple is actually in the road that will lead them to become millionaires. On how? Save RM2,500 per month and given 12% returns on their savings, they say start at the age of 25 years (married young).
Before they reach 45 years of age and get wealth, amounting to RM2,473,138.41. Yes, almost RM2.5 million. And this is the only think that kept wages wife could not go up for 20 years. A couple achieved millionaire status in 38 years of age. All of this is the power of compound interest.
If you are not excited by these figures, let me explain more about the kompound interest and the interest compounds the key to success. The key to interest compounds. That is, start by quickly. If you delay starting your savings, interest kompun delayed effects.
The answer is very simple, infact, it is no longer a secret because in any personal finance books in the world, surely there is a telling chapter in this way. Means that 100% if used will make us millionaires. Yes, you too can become millionaires if this manner. No matter our background, no matter the level of intelegent us, no matter what our expertise, there is a way to be sure that someone is a millionaire. However, not many people really take advantage of this because of Islamic Religion especially forbidden to do so. The Qur'an explicitly mentions compound interest as a great sin. Usury (oppressive interest), known in Arabic as "riba", is considered wrong.
Compound interest from others perspective.
Several writers I studied traced the concept of compound interest to the Sumerians, whose empire included fabled Babylon. Could it be that compound interest and its questionable value is another "gift" to us from Babylon, the kingdom and system against which God declares eternal vengeance?
Although Jubilee justice of the Bible allows no interest to be charged to fellow Israelites, there may be some cases where reasonable simple interest is both just and necessary. Economists use the term opportunity cost to describe the cost of other lost opportunities when money is devoted to one cause, such as making loans. So perhaps a low amount of simple interest would reward one for using money to make a loan rather than spending it upon oneself. And theres the additional element of risk, which also needs reasonable compensation.
But never should interest be charged on funds loaned to the poor for their subsistence, nor should unpaid interest be used as a reason for foreclosure on productive assets or personal dwellings. Our legal system generally protects moderate home equity from loss in bankruptcy cases, but not against foreclosure due to lapsed mortgages. Why not?
The effect of compound interest
We've all seen articles on the wonders of compound interest. But most of us don't have large sums of money just lying around waiting to be invested wisely. So we're going to see how us 'poor folks' can apply compound interest to make a difference in our lives.
Time and compound interest, however, are a double edged sword. That 14% interest you're paying on your credit card debt is actually much higher if you figure in compound interest.
now let's get down to how us poor folks can take advantage of compound interest. Could you find a way to save RM5 per month? Maybe skip lunch at McDonalds or rent fewer videos each month. If you drive a lot you might save 2 gallons of petrol by getting rid of the extra weight in the trunk of your car. Maybe send a couple of handwritten notes instead of greeting cards. If you look and you really want to, you'll probably find some way to save that $5 each month.
But, at that rate it'll take forever to save anything. Well, let's see. If we save RM5 per month, earn 5% interest compounded monthly and continue to do that for 10 years what'll we save? Well, we'll have saved RM600 (120 x 5). But the account will be worth RM776. That's enough for a purchase or repair bill.
You do not understand and have credit card debts. We people cannot save money. Oh, but you're wrong my plastic using friend. Let's suppose you take that RM5 per month and add it to your credit card payment. You'll actually do better than the saver. Let's assume that your credit card interest rate is 14% annually. After ten years you'll have paid off an additional RM1,315 in credit card balance.
More time magnifies the effects of compounding. Let's say you put some money away today at 5% interest. That money will double in about 14 years. If you left the interest in the account you'd have twice as much money earning interest in years 15 through 28. It's like you were getting 10% interest on your original savings. By year 29 you'll be earning 20% interest on your original savings! The rest of the account will earn a less depending upon how long it's been in the account.
Another great mind of the Twentieth Century, the philosopher and theologian Alfred North Whitehead, believed that everything in the universe is constituted by its relationships to other things. Whitehead is the source of what has come to be known as process thought.
In addition to an intensity differential, there is another difference between simple and compound relationships. If my identity is constituted by my relationships, I need to take other people and other things seriously. In part, they make me who I am. Simple relationships are those in which I deny this fundamental reality and act like everything is about me. Compound relationships, on the other hand, are ones in which I recognize the truth: my life is indeed about me, but it's also about other people and other things as well. Value comes from relationships that are both substantial and reciprocal.
In terms of our everyday experience, simple relationships focus only on how useful or obstructive others are to helping us get what we want. Each person in our lives has a functional role: customer, sibling, competitor, parent, employee, investor, teacher, friend, boss, teammate, or subordinate. We also view the elements of the natural world in an instrumental way: air is to breathe, water is to drink, land is to develop, trees are to harvest, oil is to drill for, and crops are to engineer. When our national interest is defined one-dimensionally, other nations are either with us or against us, friend or foe, loyalist or traitor.
The problem with this approach is that it severely limits the value we can create. This has become painfully clear to our nation in recent months. We are learning the hard way that much of what happens in the world is not about us and what we want. If democracy eventually comes to Iraq, it will come because the people of Iraq long for it, not because our military insists on it. Our mistake as a nation is not that we want freedom from tyranny for the Iraqi people. Our mistake is in believing that our view of things is the only one that must be taken into account. I am deeply troubled by the disdain for human dignity shown in the Abu Ghraib prison. But I am also troubled by how those actions mirror with appalling clarity our wide-ranging disdain for other interests and other points of view. Value comes from relationships that are substantial and reciprocal. We will always be better off when we understand the truth: our interests are compound.