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Understanding Compound Interest
Learn how compound interest works and why Einstein called it the eighth wonder of the world.
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Frequently Asked Questions
- What is the difference between simple and compound interest?
- Simple interest is calculated only on the principal amount, while compound interest is calculated on the principal plus any accumulated interest. Compound interest leads to exponential growth over time.
- How often should interest compound for maximum returns?
- The more frequently interest compounds, the higher the returns. Continuous compounding provides the maximum return, followed by daily, monthly, quarterly, and annual compounding.
- What is a good rate of return for investments?
- Historically, the S&P 500 has averaged about 10% annually. However, "good" depends on your risk tolerance, investment timeline, and goals. Conservative investments might target 3-5%, while aggressive strategies might aim for 15%+.
- How does inflation affect my investments?
- Inflation reduces the purchasing power of money over time. To calculate real returns, subtract the inflation rate from your nominal return. For example, a 7% return with 3% inflation gives you a 4% real return.
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