What is a Compounding Interest Rate?

While it is sometimes covered in mundane pre-calculus math classes, it is often overlooked as a method to gain more money on as little as one dollar. We are talking about Compound Interest rates! Described in early as 1906 as being one of man’s most remarkable inventions, compounded interest rates have been placing academics in awe for a long time. Essentially, a compounded interest rate is one that gets compounded (added to) a certain amount of times throughout a calendar year. It is commonly called interest on interest. Compounded interest rates are a way to better both corporations and personal income earners. For example, if you have one US dollar that will be compounded twice a year and earns a 10% interest rate then it would look something like this:

● $1.00 X 1.1(interest rate) = $1.10 (First compounding interest period)

● $1.10 X 1.1(interest rate) = $1.21(Second compounding interest period)

Now that you have a general idea of the theory behind compounding interest rates, let try another, more difficult, problem, but with a handy formula.

FV = PV x [ 1 + (i / n) ] (n x t)

● FV = Future value of your money

● PV = Present value of your money

● i = interest rate on your money

● n = # of compounding periods/year

○ Yearly Compound= 1; Quarterly compound= 4; Daily compound= 365

● t = # of years

How much would an original investment of $200 be worth if it were to be compounded quarterly for two years at an interest rate of 4% (.04)?

FV = PV x [ 1 + (i / n) ] (n x t)

FV = 200 x [ 1 + (.04 / 4) ] (4 x 2)

FV= 428.71

Make sure to check out our “Time Value of Money” article to learn more about this super important personal finance topic!

¹ Garson. “Compound Interest Is Man’s Greatest Invention.” Quote Investigator. October 31, 2011. Accessed May 31, 2018. https://quoteinvestigator.com/2011/10/31/compound-interest/.

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