CAPUT58

In simple interest theory, a capital sum of $100 that is accumulated at 5% per annum would derive an interest amount at the end of the year of $5. If the interest is not included in the capital sum, a 5 year interest accumulation at the same amount and interest rate would mean a total of $25 in interest earned. There is therefore no re-investment of interest.

With compound interest, the amount of $5 is added onto the initial $100 and becomes additional capital sum to be invested at 5%. The total amount derived where the initial capital p is accumulated over n years at an interest rate of i% is $127.63.

The interest of $27.63 earned through compounding the interest over the same duration is $2.63 more than interest earned under the simple interest method.

Rule of 72, as it is commonly called, allows us to measure how fast an investment is gaining in value. By dividing the number 72 by the interest rate, we can then ascertained the number of years it will take for a value to double itself. However, there are other factors which should be considered when using this rule such as inflation rate and interest rate achievable.

For example, assuming an interest rate of 5%, it will take an investment of $250,000 to double in value to $500,000 in approximately 14 years (72/5 = 14.4 years).

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