Calculate both the simple and compound interest:
Compound interest is different from simple interest because it is calculated based on both the initial amount invested, known as the principal, and the accumulated interest over time.
Simple interest is calculated only on the principal amount, whereas compound interest takes into account the accumulated interest as well. This means that with compound interest, the interest earned in each time period is added to the principal, and the interest for the next period is calculated based on the new total.
For simple interest, after one year, you would earn $50 (5% of $1000), and your total investment would be $1050. After two years, another $50 would be earned, bringing the total to $1100, and so on. The same amount is earned each year since it is based on the initial investment.
For compound interest, after one year, you would earn $50 (5% of $1000), bringing the total to $1050. However, in the second year, the 5% interest would be calculated based on the new total of $1050, resulting in $52.50 being earned. This brings the total to $1102.50. In subsequent years, the interest earned would continue to be based on the new total amount.
In real life, compound interest is commonly used in savings accounts, investments, loans, and mortgages. It allows for exponential growth over time and can significantly impact the final amount earned or owed.
By using a compound interest calculator, individuals can determine the future value of their investments or the total amount of interest they will need to pay on a loan. It provides a precise and accurate way to calculate the impact of compound interest on financial transactions.