Why do compound interests give you a larger value than a simple interest?

Question

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Answer 1

Compound interest is the measurement of interest in which interest that becomes payable is added to the original principal. When new interest is calculated, it is based not only on the original principal, but also on the interest that has been added to the principal. The more frequently interest is compounded, the faster the principal grows.

Interest rates must be comparable in order to be useful. Since most people think of rates as a yearly percentage, many governments require financial institutions to disclose the comparable yearly interest rate on deposits or advances. Compound interest rates can be called variously Annual Percentage Yield, Annual Equivalent Rate, Effective Annual Rate, Effective Annual Interest, Effective Compound Interest.

The alternate way of measuring interest is called simple interest. It does not add the interest to the principal. It prorates a (usually) shorter period into the disclosed yearly percentage by simple multiplication. Eg. 1% payable monthly is disclosed as 12%. The economic reality, that any interest paid before the end of the year could be put to use earning more income, is ignored in this model.

Good Luck!!!

Answer 2

Both answers above are correct, but let me give you an example.

Suppose you invest $10,000 at 12% for one year, sinple interest. At the end of the year your investment will be worth $11,200 (112% of your original investment).

If you got compound interest on the same investment, and this interest was paid monthly, at the end of January your investment would be worth $10,100 (101% of your original investment). At the end of February, it would be worth $10,201 or 101% of the amount you had in January. By the end of March, you would have $10, 303.01. By the end of the year, your investment would be worth $11268.25030131969720661201, just over $68.25 more than what it would produce at simple interest.

Answer 3

simple interest works out the interest based on the initial value, where as compound interest accumulates interest on the initial value and any interest already paid.

Answer 4

because compound interest earns interest on the interst every time
for example if u have a compound interest every 6 months then the 2nd six months u will have princple + interest of 1st six months as ur new princple and interest s given on this new princple.