Investment Journal

If you are serious about saving or investing your money, you should understand compound interest. But if you think you're not yet ready to enter the investment world, and you think that you still have to wait 3 or 5 more years before you start saving money, then I think you're the one who really needs to understand the power of compound interest. Learning its importance and power may make you realize that you should start saving money NOW.

Q: What is compound interest?

A: It is simply an interest earning interest. Sounds simple? Yeah, but it is really powerful.

Q: How?

A: Let me give you an example:

Let Say you and your friend each has P100,000 to invest. Your friend chooses an account yielding simple interest at 5 percent. This means that each year his money is increased by P5,000, 5 percent of the principal investment P100,000. After year one, he has P105,000; after year two, P110,000; after year three, P115,000; and so on.

You, on the other hand, put your P100,000 in an account that returns 5 percent compound interest. This means that you get interest not only on your original P100,000, but on the interest that is added to it as well. At the end of year one, you will also have P105,000. In year two, you earn another 5 percent, but now it's 5 percent of P105,000, not of P100,000. So instead of getting P5,000 you get P5,250, bringing your total investment to P110,250. The third year, you get P5,513 The fourth year you get P5,788. Why does the interest keep on growing? Because you reinvest the interest you get every year, and that what makes your money grow faster. After 20 years, your friend's total investment will be P200,000 and your total investment will be P265,329.77. In this example, we only use 5% interest rate. What if we use 10% instead of 5% interest rate? After 20 years, your friend's total investment will be P300,000 and your total will be P672,749.99!