Simple Interest vs Compound Interest
Business & Finance

Simple Interest vs Compound Interest

New investors mostly try to find a high-interest paying opportunity to beat inflation from eroding their investments. But seasoned investors are those who not just only look for high-interest avenues but also for those which offer them compound interest. So the question arises, how is compound interest superior to simple interest?

Concept wise compound interest is quite lucrative but does not be deceived by its simple nature. Compound interest can lead to a significant return on your investment. Before jumping onto any investment, calculation of the right outcomes of interest is a must and it should be part of your business plan for daily execution.

How does Compounding work?

Compounding refers to the mechanism whereby you can earn interest on the interest you have earned. Let me simplify that a bit. When you earn interest on your original investment, you have the option of investing interest earned and thus earning interest on your “return”.

Where can you get compound interest opportunities from?

As far as investment with interest as a return in concerned, Peer-to-Peer lending platforms are the talk of the town. Many of these platforms are offering compound interest, and rates which are giving a tough time to traditional banks.

However you must understand that with compound interest you will have to forgo monthly withdrawals. Compound interest is usually paid lump-sum at the end of the “term”. The term is the period you have to invest for. You should expect the minimum term to be one year.

Understanding the math behind Compound Interest

Now that you know what compound interest is, you should take some time to understand how it is calculated so you can better compare investment opportunities.

Let us start with a simple example. Assume you have USD 10,000/- and you invest it at 4% per annum. So what you will earn at the end of the year is USD 10,000 x 4%, equals to £400. And if you had invested this amount for 4 years, that means a return of £400 x 4, equals to USD 1600.

Now, what if you had invested this amount in a peer-to-peer lending platform offering compound interest?

Let us better understand with a table:

Year Investment Amount Interest % Interest earned Value of your investment at year end
       1 10,000 4% 400.00 10,400
       2 10,400 4% 416.00 10,816
       3 10,816 4% 432.64 11,249
       4 11,249 4% 449.95 11,699

So when you invested USD 10,000/- in a simple interest opportunity you got USD 1600 as a return but when you invested the same amount in an compound interest opportunity you were better off by USD 99! This is quite the difference. If you have limited funds, compound interest makes those funds work harder and give you the opportunity to earn the most possible.

Who should invest in peer-to-peer lending?

Peer-to-peer lending is for everyone. But one section can particularly benefit, the people with less funds.

College students should especially look into this. Most college students do save by going for second-hand textbooks and restricting their social life however the next step is to invest these savings somewhere and beat inflation. There are many peer-to-peer lending platforms, and some even allow investments of as low as USD 10.

However one cannot stress enough on how important it is research the avenue where you are investing. Research its history and credibility.

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