In the real world, borrowing money usually incurs additional costs. When you take a loan from a bank, you repay the borrowed amount plus an extra amount that depends on the loan amount, the time you borrowed it, and the interest accrued over previous periods. This extra amount is known as compound interest.
Compound interest is the interest calculated on both the initial principal and the accumulated interest from previous periods. It is a concept frequently encountered in our daily lives. Unlike simple interest, which is calculated solely on the principal, compound interest takes into account the interest accrued over time, making it dependent on both the principal and the accumulated interest. This is the key difference between compound and simple interest.
Compound Interest (CI) = Principal (P) × (1 + Rate (R)/n)^(n×Time (T)) - Principal.
Credit Cards:
Credit cards typically charge compound interest on unpaid balances. If you carry a balance from month to month, the interest is calculated on the outstanding amount, including any previously accrued interest, leading to faster debt accumulation.
Investments:
Investments in stocks, bonds, or mutual funds can benefit from compound interest. As the value of your investments increases, any interest or dividends earned are reinvested, leading to higher returns over time.
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