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Finance Definitions Videos 800 videos

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Finance: What is Compounding Value or Compounding Interest? 1771 Views


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What is compounding value or compounding interest? Compound interest or value basically makes an investment grow much faster. This is because of the way that interest is calculated, specifically by paying interest on interest. Not only is interest being paid on the principal, it’s also paid on all previous interest payments.

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Transcript

00:00

Finance allah shmoop What is calm Pounding value or compounding

00:06

interest Ah the power of compounding it makes tree's stronger

00:12

pollution More feral and the rich Well richer How so

00:16

Well let's start with compounds kissing cousin with six toes

00:20

Arithmetic calm pounding Right So the first was really geometric

00:24

compounding Now we're talking about arithmetic compounding If you invest

00:27

a thousand bucks in a ten year bond that pay

00:29

six percent a year in interest the dough comes back

00:32

to you in a pattern that looks like this Like

00:35

every six months they pay thirty bucks and it's sixty

00:38

dollars a year Got it nice You get the total

00:41

of sixteen hundred bucks back from your investment And the

00:44

cash that came back to you you know came in

00:47

small parts all along the way until you got about

00:50

two thirds of it or sixty percent at the end

00:52

right If you just spent that money and collected your

00:55

thousand bucks at the end That's it Okay So that's

00:58

arithmetic compounding the money comes to you You don't reinvest

01:01

it Ding ding ding that's the key here and you

01:03

just go buy burgers Okay So now let's look at

01:07

what six percent compound id looks like over the same

01:10

ten year period Wealth at the end of your one

01:12

it's a thousand sixty bucks and no we're only going

01:14

to compound it annually We probably should do the semi

01:17

annually but we confuse you even more is we won't

01:19

do that but then you essentially re invest that money

01:22

and you get another six percent compounded on that thousand

01:25

sixty instead of six percent compounded against the original thousand

01:29

so by the end of your two you'll have a

01:31

thousand one hundred twenty three sixty and by the end

01:34

of your ten you'll have one thousand seven hundred ninety

01:36

dollars and eighty five cents So why do you make

01:40

so much more money when you compound interest versus getting

01:44

thirty bucks twice a year like you would in this

01:46

bond example going by and burgers with it You don't

01:49

wanna do that well essentially what's happening is that you're

01:52

delaying your gratification of getting that sweet sweet cash or

01:57

getting liquid Whatever you wanna call it by reinvesting your

02:00

gains year after year after year So do you have

02:03

that sort of self control Do you need the cash

02:06

Yeah that's The question If you for example have trouble

02:09

making it home from your local pizza spot with the

02:12

pie intact well and compound interest Keeping the discipline to

02:16

not spend the money today and wait for the happiness

02:18

tomorrow Well when that may not be for you Sorry

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