Financial Planning and Money Management

Interest

is the price paid for the use of anothers money.

Principal - The amount borrowed or invested Interest Rate - A percentage of the outstanding principal Time The number of years or fractional proportion of a year that principal is outstanding

Simple interest is determined on the

principal only.

principal x interest rate (%) x time

Compound interest is determined on:

the principal, and any interest earned (and not withdrawn). Compound interest is the typical computation applied in most time value applications.

Simple Interest = Principal * Rate * Time. If $100 was borrowed for 2 years at a 10% interest rate, the interest would be: $100(.10)(2) = $20. The total amount that would be due would be $100+$20=$120.

Simple interest is calculated on the original principal only. Accumulated interest from prior periods is not used in calculations for the following periods. Simple interest is normally used for a single period of less than a year, such as 30 or 60 days.

Because compound interest is a really marvelous invention. Albert Einstein (1879 1955) called it the 8th Wonder - It can work for you, or against you. When you invest it works for you. When you borrow it works against you!

Compounding is a mathematical phenomenon that basically means the longer you stay invested - and reinvest your earnings - the faster your money will grow! Therefore, the two important keys to taking advantage of the power of compound interest are: 1. Leaving your money invested in the markets for the long run and 2. Reinvesting your income and gains.

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.

Tells you how long it will take for your money to double Divide 72 by an interest rate to determine the number of years it will take your money to double

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For example, assume you can earn 6% on your money. How long will it take $100 to grow to $200?

72 / 6% interest = 12 years

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On the other hand, say you have a set time period in mind. You can figure out what interest rate you need to earn to double your money. If you have $200 today and need a total of $400 in eight years, what interest rate do you need to earn? 72 /8 years = 9% interest

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