What is Compound Interest?
Compound interest is often called the "eighth wonder of the world" because of its powerful ability to grow wealth over time. Unlike simple interest, which is calculated only on the principal amount, compound interest is calculated on both the principal and the accumulated interest.
How Compound Interest Works
When you invest money, you earn interest on your principal. In the next period, you earn interest on your principal PLUS the interest you previously earned. This creates a compounding effect that accelerates wealth growth over time.
The Formula
A = P(1 + r/n)^(nt)
- A = Final amount
- P = Principal (initial investment)
- r = Annual interest rate (decimal)
- n = Number of times interest compounds per year
- t = Time in years
Example in Malaysian Context
If you invest RM10,000 in a fixed deposit at 4% annual interest rate:
- Year 1: RM10,000 + RM400 = RM10,400
- Year 2: RM10,400 + RM416 = RM10,816
- Year 3: RM10,816 + RM432.64 = RM11,248.64
- Year 5: RM12,166.53
- Year 10: RM14,802.42
Why It Matters for Malaysians
In Malaysia, understanding compound interest is essential for:
- Fixed Deposits - Most banks offer competitive FD rates
- Unit Trusts - Long-term growth through reinvested dividends
- EPF - Your retirement fund compounds over your working life
- ASB - Amanah Saham Bumiputera offers dividend compounding
Key Takeaways
- Start investing as early as possible - time is your greatest ally
- Reinvest your earnings rather than withdrawing them
- Be aware of the difference between nominal and effective returns
- Consider tax implications on your investment returns
- Remember that compound interest works both for and against you - credit card debt compounds quickly!
Disclaimer
This article is for educational purposes only. Past performance does not guarantee future results. Always consult with a qualified financial advisor before making investment decisions. Your specific circumstances may require different strategies.