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What is the difference between simple interest and compound interest? (For US)

Curious about Compound interest

What is the difference between simple interest and compound interest? (For US)

The frequency of compounding can have an impact on the total amount of interest earned. Generally, the more frequently interest is compounded, the higher the total amount of interest earned.

When interest is compounded more frequently, such as daily or monthly, the interest is calculated and added to the principal more often. This allows the interest to earn additional interest, resulting in higher overall returns.

For example, let's consider a principal amount of $1,000 with an annual interest rate of 5% and a time period of 1 year. If the interest is compounded annually, the total interest earned would be $50, resulting in a final amount of $1,050.

However, if the interest is compounded quarterly, the interest would be calculated and added to the principal four times during the year. Each time, the interest would be calculated based on the updated principal amount, resulting in a higher total interest earned. In this case, the total interest earned would be approximately $51.62, resulting in a final amount of $1,051.62.

As the compounding frequency increases, such as daily or continuously, the total interest earned approaches the concept of continuous compounding, where the interest is calculated and added infinitesimally over time. This leads to the maximum possible interest earned for a given interest rate.

It's important to note that the impact of compounding frequency becomes more significant for longer time periods and higher interest rates. Therefore, understanding the compounding frequency and its effects can help individuals make informed decisions about their investments and savings.

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