Identifying the simple and compound interest rate in investment is one of the most important steps when putting your money into production.
One of the areas of finance that most attracts my attention is the issue of investments. It is a fascinating world, and within this what is related to simple and composite interest. That is the way in which investments interact the value of money over time. I show you what these differences are and how you can incorporate them into your financial management.
What is the interest rate?
Before entering the subject, and although I have already published a blog post where I answer the question: What is the interest rate? , I want to give a brief explanation of it. Since it is possible that it is only seen as a burden (in the case of loans) or as something that is earned (in the case of investments).
The truth is that the interest rate represents the value of money over time. And this response to the natural devaluation of money. What does this mean? That before you buy more things with the same amount of money. That is, with the $ 10 of 8 years ago you could buy more things than with the $ 10 now.
In that sense, interest was created, which tries to compensate for that loss of value over time, so that the money that is available does not lose capacity? That is to say, that those $ 10 of 8 years ago become $ 12 today and that the same things can be acquired.
What is Simple and compound interest?
I vividly remember the first time I heard about simple and composite interest in college. It was in the subject of financial mathematics, and in it, the professor explained the mechanical part of finance, more specifically, in the area of investments and debts.
For me, everything was the same, until the teacher takes the chalk and begins to explain everything on that blackboard. At first I did not understand much, I just got the idea that with one of the two you earned more money than the other; and, literally, I asked him: Professor, what do you eat that with?
And the wise way in which he explained it to me was the following: “My son, that is eaten with benefits and time”. Of course, it was more detailed with his explanation, but only with that phrase, everything made sense. Since at the end of the day, simple and compound interest is reduced to the results obtained in a given period; and the way they allow you to make a decision.
In other words, to understand it you have to start from the natural dynamics of money, which is summarized in movement. Having a quantity of money, whatever it may be, static does not produce. Therefore, it is devalued and has no meaning. It is for this reason that it is necessary to incorporate it into personal financial management, since to the extent that you have the knowledge of this, then you will have better results in your investments.
What is the difference between simple and compound interest?
To make it very simple, the difference lies in the way in which it interacts with capital. It seems that I was not very simple with the explanation. Perhaps the best way to explain it is with an example.
Imagine that you go to a bank and want to open a certificate of deposit. When you get to customer service you will be asked the following: “Do you want to receive the benefits to an account or reinvest them to the capital?” And in that question, the difference between them is summarized.
Simple interest responds to an event, which can be repeated but cannot be exponentiated. While the compound is recalculated on the basis of a new amount. That is, each time you generate a benefit this is added to the capital and the interest is recalculated on the result of what you earned plus the capital invested, and this formula of interest is repeated again and again, while the certificate of deposit is valid.
How to take advantage of this?
Based on this, one of the questions that may arise is how to take advantage or how to make an investment strategy based on these two alternatives; and all this will depend on your investment profile. In other words, whether through interest capitalization or simple interest calculation, a value can be added to personal financial management, since each response to a particular type of strategy.
And this goes in the following way, the simple interest has the intention of supplying liquidity, while the compound capitalization seeks to swell the money over time. Which means that the first (simple) is for the short term and the second (compound) for the long term.
This gives you a more complete overview of how you can take advantage of your investments. Since you know that if what you are looking for is to manage money quickly, then you have to choose the simple interest option, whereas if you are looking to accumulate money for something future, then compound interest is your best options business plan.
How to calculate simple and compound interest?
This is not something that I am usually asked for, but I have a hunch that you might be interested, since you may well, before making any investment move carry out the simple and compound interest calculation to determine which one suit you best.
For this, you can help the electronic spreadsheets that allow you, through the functions carry out this calculation.
Identifying the simple and compound interest rate in investment is one of the most important steps when putting your money into production. It depends on them whether or not you have success in your capitalization process, and that is why understanding them is of the utmost importance.
Their difference lies in the way they interact with capital. One focused on the short term (simple) while the other on the long term (compound) so if you have intentions to invest in instruments that allow you to have these options, then you should ponder the option that suits you according to what you have in mind to do.
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