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Saving and Interest February 2014

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Saving and Interest An Equation to define Savings: – SAVING = Disposable Income – Consumption. Interest: – Simple Interest = The annual interest paid on the initial amount saved. – Compound Interest = The interest paid on both the initial principal amount AND the interest added to the principal.

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Interest earned on an initial $100 saved at 8% interest YearSimple interest adds Total saving using simple interest Compound interest adds Total Savings using compound interest 1$8.00$108.00$8.00$108.00 2$8.00$116.00$9.00$117.00 3$8.00$124.00$9.00$126.00 4$8.00$132.00$10.00$136.00 5$8.00$140.00$11.00$147.00 6$8.00$148.00$12.00$159.00 7$8.00$156.00$12.00$171.00 8$8.00$164.00$14.00$185.00 9$8.00$172.00$15.00$200.00

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Compound Interest Example Simple interest: Is interest paid on the initial principal amount at a given rate for a specified time. – I = P x R x T Compound interest: Is interest that is paid on both the principal and also on any interest from past years. For example, if you received 15% interest on a $1000 investment, the first year and reinvested the money back into the original investment, then in the second year, you would get 15% interest on $1000 and the $150 I reinvested. Over time, compound interest will make much more money than simple interest. The formula used to calculate compound interest is: – M = P( 1 + i ) n M is the final amount including the principal. P is the principal amount. i is the rate of interest per year. n is the number of years invested. – Applying the Formula Let's say that you have $1000.00 to invest for 3 years at rate of 5% compound interest. M = 1000 (1 + 0.05) 3 = $1157.62. You can see that the $1000.00 is worth $1157.62.

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The Rule of 72 The rule of 72 is a simple way to illustrate the magic of compound interest Rule of 72 – 72 divided by the rate of interest = the number of years it will take for a saved amount to double when interest is allowed to compound. – Example: Compound interest at 8% for 9 years 72/8 = 9 At the end of 9 years the initial amount saved of $100 has doubled to $200. (see table).

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