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Saving and Interest

Saving and Interest. February 2014. Saving and Interest. An Equation to define Savings: SAVING = Disposable Income – Consumption. Interest: Simple Interest = The annual interest paid on the initial amount saved.

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Saving and Interest

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  1. Saving and Interest February 2014

  2. Saving and Interest • An Equation to define Savings: • SAVING = Disposable Income – Consumption. • Interest: • Simple Interest = The annual interest paid on the initial amount saved. • Compound Interest = The interest paid on both the initial principal amount AND the interest added to the principal.

  3. Interest earned on an initial $100 saved at 8% interest

  4. Compound Interest Example • Simple interest: Is interest paid on the initial principal amount at a given rate for a specified time. • I = P x R x T • Compound interest: Is interest that is paid on both the principal and also on any interest from past years. For example, if you received 15% interest on a $1000 investment, the first year and reinvested the money back into the original investment, then in the second year, you would get 15% interest on $1000 and the $150 I reinvested. Over time, compound interest will make much more money than simple interest. The formula used to calculate compound interest is: • M = P( 1 + i )n • M is the final amount including the principal. • P is the principal amount. • i is the rate of interest per year. • n is the number of years invested. • Applying the Formula • Let's say that you have $1000.00 to invest for 3 years at rate of 5% compound interest. • M = 1000 (1 + 0.05)3 = $1157.62. • You can see that the $1000.00 is worth $1157.62.

  5. The Rule of 72 • The rule of 72 is a simple way to illustrate the magic of compound interest • Rule of 72 • 72 divided by the rate of interest = the number of years it will take for a saved amount to double when interest is allowed to compound. • Example: Compound interest at 8% for 9 years • 72/8 = 9 • At the end of 9 years the initial amount saved of $100 has doubled to $200. (see table).

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