What is compound interest and why is it favourable?

1 ANSWERS

1. Victor Strong
   

   With regards to  investments, interest is earned on the amount of money that is invested, known as the principal. Simple interest is calculated as a percentage of the overall principal amount over a period of time (usually annually) and is paid as incentive for borrowed funds. 

   
   

   Compound interest is preferred by investors due to the fact that interest accumulates not only on the pricincipal over time, but also on all the interest that is earned as well. This means that the interest earned over time is added to the principal, making a larger base to earn interest on. Over time as interest is continually added to the principal amount, it creates exponentially more investment income as compared to simple interest. This effect is even further exacerbated when the compounding frequency increases. This increase means interest is added to the principal sooner, thereby increasing the overall earning potential.

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