## Wednesday, September 1, 2010

Most of you may have learned simple interest and compound interest at some point in school and you probably still have a rough understanding of simple interest.  Compound interest however, is a bit “iffy”. What was that formula again?  Could you pull that off if someone asked you on the street?  Probably not...but you don’t really have to as long as you have a rough estimate of how compounding interest can affect your money.
You can use the Rule of 72 to quickly estimate how many years it takes to double your money at a given interest rate.  Albert Einstein, one of the most famous scientists of modern times, loved the Rule of 72 and referring to compound interest, is quoted as saying:
"Compound interest is the greatest mathematical discovery of all time"
If you can remember E = mc² you should be able to remember this:
72 ÷ interest rate =  # of years to double your money
Example: 72 ÷ 10 (%) = 7.2 (years)
\$1,000 invested at 10% would take 7.2 years to grow to \$2,000
Remember, this formula is an approximation not 100% accurate, but pretty close.  If you’d like to calculate numbers to the nearest cent, here’s the actual compound interest formula:
Pn = P0 (1+r)n
Where,
Pn = Future Value
P0 = Present Value or Principal
r = interest rate (per year)
n = time (in years) a.k.a. compounding periods

For questions, comments and suggestions, please feel free to use the commentary section or email: clemens.kownatzki@fxistrategies.com