What is simple and compound interest?

Simple interest is the total growth over a period, divided by the number of months or years. This concept can be explained better by an example. Suppose you invested R100 for 5 years and at the end of the period you get back R160. This is a profit of R60. The simple interest you achieved is 12% per year. This can be calculated by dividing the R60 growth, by the 5-year period. Similarly, you can calculate the monthly growth by dividing the R60 by the months you have been invested. In this case, the number of months is 60 and your monthly simple interest that you have earned was 1%.

Now for the more complex one, compound interest. Compound interest is when you earn interest on the capital amount and the interest from the previous period. So, let us suppose that you earned 12% compound interest on your R100 instead. After the first year, you will have R112. During the second year, you earn 12% interest on the R112. This leaves you with R125.44. After the 3rd, 4th and 5th year you will have R140.49, R156.35 and R176.23 respectively. The R176.23 you are left with at the end of 5 years’ compound growth is more that the R160 after the 5 years’ simple growth. This is the power of compound growth. This is the growth that should be used when comparing investments. Always double check whether the growth quoted is compound or simple interest.