Compound interest, also known as compounding interest is the interest that is calculated on the original principal and also on the interest that has accumulated over the previous periods of loan or deposit. In many cases, compound interest is thought to increase a sum at a faster rate than the simple interest. It was proven by the case of Benjamin Franklin.
The case of Benjamin Franklin on Compound Interest
Benjamin Franklin died in the year 1970 but before that he left for the cities of Philadelphia and Boston approximately $4,400 each on the condition that the money will be loaned and invested to apprentices who has proven to be worthy of a loan ( Murphy, 2013) . He further states that the cities would access part of the funds after around one hundred years and receive the rest of the money after 200 years. The results of his efforts after the 100 years saw each city withdrawing $500,000 so as to facilitate public works projects. In addition, after 200 years, in the year 1991, both cities received the balance which is estimated to have compounded to $20 million for each city. The experiment is a clear indication of the benefits of compounding according to the words of Franklin, that money makes money ( Ross, 1998) .
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Retirement Money
Money after 30 years
1500(1+0.126) 30 - 1500= 51,252.49
Money after 40 years
1500(1+0.126) 40 - 1500= 171,333.08
From the calculation, it is evident that the longer the amount is compounded, the higher the returns that would have after retirement. It proves the fact that compounding the interest increases the sum at a faster rate. Evidently, compounding is vital because it increases the value of money at a faster rate compared to the normal interest calculation.
References
Murphy, F., Walz, R., & Overdrive Inc. (2013). Ben Franklin and the Magic Squares . S.I.: Random House Children's Books.
Ross, S. A., Westerfield, R., & Jaffe, J. F. (1998). Corporate finance . Boston: Irwin/McGraw-Hill.
