Discuss the effects of compounding interest. How can you use this knowledge to h

Question

Discuss the effects of compounding interest. How can you use this knowledge to help structure your financial plan. Also discuss some of your ideas on risk when looking for higher interest rates. There are many banks, credit unions, savings and loans corporations and other financial institutions seeking your business, What are you going to demand as a consumer? Discuss the effects of compounding interest. How can you use this knowledge to help structure your financial plan. Also discuss some of your ideas on risk when looking for higher interest rates. There are many banks, credit unions, savings and loans corporations and other financial institutions seeking your business, What are you going to demand as a consumer?

Explanation / Answer

Compounding refers to earning interest not only on the principal amount but also on the interest. For example: If a deposit of $100 is made at 10% interest for 2years, under simple interest, the amount of interest earned would be $20 and the amount would be $120 after 2 years. However under compounding, the amount of interest earned in year 1 would be 10%*100 =$10 and interest earned in year 2 would be 10%*110 = $11. This brings the total amount after 2 years to be $121.

This knowledge will help me select the assets which offer compound interest rather than simple interest. However it is to be kept in mind that higher interest rates generally are associated with higher risk. This is because the investors need to be compensated for the risk that they are undertaking. As a consumer I would demand a balance between risk and interest. Ideally, I would look for a least risk opportunity with highest possible interest rates.

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