You might see advertised interest rates by a savings bank or an investment fund telling you how much interest you can earn by investing with them.
When a borrower receives money, let’s say from a bank, he or she agrees to pay a certain percentage, generally calculated annually, to the lender for the use of the money.
The borrower and lender also agree on a payment schedule for the money to be returned. and penalties that will occur if a borrower fails to meet the agreed payment schedule.
Here are two principal types of interest—Simple Interest and Compound interest—which are explained below. Also included is the formula for the Rule of 72, which will quickly show you how long it will take you to double your money when investing or what it will cost you in interest when you borrow money.
Simple Interest. How does simple interest work? Interest of any kind, especially when it is being paid out to you, is great, because it means that your money is working for you. Let’s say you put R500 in a bank which gives you 5% interest.
This is an annual interest rate, which most of the time is calculated daily and charged monthly. The bank pays you for the use of your money. If you leave your R500 in the bank for an entire year, at the end of the year you will have earned R25 (R500 (your capital deposit) x .05 (5% interest) = R25). Therefore, at the end of the year you now have R525 in your account without you lifting a finger.
“Compound interest …
“He, who understands it, earns it… he who doesn’t ….pays it. [Albert Einstein]
Compound Interest. What is better than simple interest? Easy answer, something called Compound Interest. Not only will you earn money on what you have saved, but you also earn money on the interest you received on that money (if you leave it in the bank). Let’s take that R500 you put into your bank. If you don’t touch it for five years, your account would be worth, R634.14. This would be compared to R625.00 if you only had simple interest, not compound interest.
Furthermore, if you continue to add money each year to your account, say R100 per year, by the end of five years your account would be worth R1 218.33. Your money keeps growing as long as you don’t touch it. Chat to your financial planner to show you how investing can put the power of compound interest to work for you.
Investing and the Rule OF 72
Compound interest rule of 72 …is the greatest mathematical discovery of all time … Einstein.
If you want to quickly work out how long it would take to double your money, use the rule of 72.
72 divided by interest rate = number of years to double your money.
- Thus If you receive an interest rate of 6%,
- Divide 72 by 6, which will give you 12.
- This means it will take you 12 years to double your money.
- The reverse: If you know you want to double your money in eight years, divide 8 into 72, which means you will need to achieve a 9% interest rate in order to achieve your 8 year goal.