Chapter 1 Planning Your Financial Future: It Begins Here
19
You
Do the Math 1-2
Investment $1,000
Year Amount
1 $100.00
2 75.00
3 85.00
4 100.00
5 75.00
6 75.00
7 70.00
8 (25.00)
9 (50.00)
10 + 40.00
Total amount ___________
Number of years ___________
Average return amount ___________
Number of years ___________
Average rate of return ___________
Check
Your
Understanding
Why is average rate of return an important concept for you to understand?
Compound Interest
You probably already understand the concept of interest. Interest is a fee paid
on borrowed money or money earned on deposits with a bank or other fi nancial
institution. The longer you keep money on deposit, the more you will earn.
To understand how time can make such a difference in your earnings, you
need to understand compound interest. Compound interest is earning interest
on the principal (amount invested) plus the interest you have already earned.
For example, suppose you deposit $1,000 at an interest rate of 5%. In one year
you will have $1,050. The next year, you will earn interest on $1,050 instead
of $1,000. The interest will be $52.50 instead of $50.
Principal × Rate × Time = Interest
Interest rates
are always stated as
one-year percentages.
To calculate interest,
you must first convert
the percentage to a
decimal. For example,
an interest rate of 5%
would be converted
to .05. A rate of 3.25%
would be .0325