Compounding and Compound Interest Explained

3 $1,025.16 1.25% $12.81 $0.16 $1,037.97 4 $1,037.97 1.25% $12.97 $0.16 $1,050.95 5 $1,050.95 1.25% $13.14 $0.16 $1,064.08 6 $1,064.08 1.25% $13.30 $0.16 $1,077.38 7 $1,077.38 1.25% $13.47 $0.17 $1,090.85 8 $1,090.85 1.25% $13.64 $0.17 $1,104.49 9 $1,104.49 1.25% $13.81 $0.17 $1,118.29 10 $1,118.29 1.25% $13.98 $0.17 $1,132.27 11 $1,132.27 1.25% $14.15 $0.17 $1,146.42 12 $1,146.42 1.25% $14.33 $0.18 $1,160.75 13 $1,160.75 1.25% $14.51 $0.18 $1,175.26 14 $1,175.26 1.25% $14.69 $0.18 $1,189.95 15 $1,189.95 1.25% $14.87 $0.18 $1,204.83 16 $1,204.83 1.25% $15.06 $0.19 $1,219.89 17 $1,219.89 1.25% $15.25 $0.19 $1,235.14 18 $1,235.14 1.25% $15.44 $0.19 $1,250.58 19 $1,250.58 1.25% $15.63 $0.19 $1,266.21 20 $1,266.21 1.25% $15.83 $0.20 $1,282.04 21 $1,282.04 1.25% $16.03 $0.20 $1,298.06 22 $1,298.06 1.25% $16.23 $0.20 $1,314.29 23 $1,314.29 1.25% $16.43 $0.20 $1,330.72 24 $1,330.72 1.25% $16.63 $0.21 $1,347.35 25 $1,347.35 1.25% $16.84 $0.21 $1,364.19 26 $1,364.19 1.25% $17.05 $0.21 $1,381.25 27 $1,381.25 1.25% $17.27 $0.21 $1,398.51 28 $1,398.51 1.25% $17.48 $0.22 $1,415.99

Do you see how the amount of interest earned is getting larger each quarter? Notice that the change in interest paid is getting larger each quarter too! That is what is meant by "exponential growth."

Rule of 72

How long does it take for an investment to double? This is where we use the "Rule of 72." This is a simple "rule of thumb" to estimate the doubling time of an investment. It is simply "the compounded annual rate of return times the number of years must equal roughly 72 for the investment to double in value."

For example, let's say you invest $1,000 at 6%. The "rule of 72" says your money will double in 72 divided by 6 or 12 years.

In Conclusion

We have seen how applying a simple interest rate of 5% over 4 equal periods in a year yields a "compound interest rate" of 5.095%. We learned that compounding means that money earns larger interest payments the longer it is held. Finally, you learned that the "rule of 72" allows you to estimate how long it will take for your money to double at a given interest rate.

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