The "com" in compound also means a bit more "com"plicated. Compound interest results in interest being calculated not only on the original principal, but also interest on the accumulated interest. As a real estate agent working with real estate investing clients, if compound interest is a factor, it's important that you know how to calculate compound interest. Of course that's easy with an interest rate calculator, but there's no substitute for at least knowing the basics and the effects of compounding.
Difficulty: Easy
Time Required: 10 Minutes
Here's How:
- Using a simple time charting method: Let's look at a $100,000 principal amount with a 6% interest rate, compounded annually for three years.
Year 1
$100,000 X .06 for one year is $6000 interest.
Year 2
Now we have $106,000 X .06 for the second year is $6360 interest.
Year 3
Starting with $112,360 accumulated X .06 = $6742 interest.
At the end of year 3 we have $119,102. As you can see, compound interest definitely beats simple interest for return.
- As a mathematical formula: This is a straight formula, but a bit trickier as we need to raise a number by a power.
Principal X (1 + Periodic Rate) ^ Number of Periods = Future Amount
$100,000 X (1 + .06) ^ 3 = Future Amount
$100,000 X (1.06 x 1.06 x 1.06) = Future Amount
$100,000 X 1.19 = $119,100 rounded off.
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Tips:
- Visitors who have found this article helpful are also reading about calculating capitalization rate.
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What You Need:
- Just a pencil or an interest calculator.
