Saturday, February 08, 2020

Simple vs. Compound Interest and the Rule of 72

  This post is a continuation of the $50 a month stock challenge I started October 14, 2019.  Click on, "No Commission Stock Trades", on the right side of the page to read from the start.

  I will be using $50 principle and 2% monthly gains for each example.

      Simple Interest = interest earned and not added to the principle.

example = $50 (principle) earning 2% interest (for any given time period) = $1

that same $50 (principle) earning 2% interest  = that same $1 for (for that same time period)

      To double that $50 (a gain of 100%) is very simple math. 100% / 2% = 50 time periods to double.

    "Any given time period", what does that mean? It could mean a day, a week, a month, a year or any other time period as long as that time period remains the same for all future calculations.

     Compound Interest = interest earned added to principle and re-calculated (compounded) each given time period.

example = $50 (principle) x 2% = $1 interest + $50 (principle) = $51
$51 (principle + interest) x 2% = $1.02 interest + $51 (principle) =  $52.02 and so on.

      Each new time period having a larger principle than the last because of "compounding" (adding) the interest gained to the last principle calculated.

     The Rule of 72, is the rule for calculating approximately  how many times (any given time period) it takes for any number to double in size using compound interest.

     The real number is very close to 69.3, but The Rule of 72, is easy to figure in ones head because it is has the most divisors, 1, 2, 3, 4, 6, 8, 9, and 12 (numbers that can evenly be divided into 72).

     Using the divisor that matches your interest rate (in our case 2 for 2%), our given time period of 1 month), 72/2 = 36 months to double our $50 using Compound Interest vs 50 months using Simple Interest. 

    Now try doing the real number of 69.3 in your head. Still not the hard using 2% but how about 9%.
            72 / 9 = 8 easy, simple division we all learned in grade school.
            69.3 / 9 = wait, where is my calculator?

    With calculators everywhere The of Rule of 72 is still not obsolete for quick and approximate math.

     Compound Interest simply means, "Let all your money keep working for you to maximum results".

Disclaimer, I am not a professional.

your comments are welcome and appreciated.



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