Always Care About Compound Interest

Rich man in car (Pixabay)

Summary

  • How works compound interest?
  • Compound interest can make you rich in the long term.
  • But only if the interest is very high or the term is long enough.
  • And if Steem had a compound interest…? It has.

From your salary to the compound interest

Let’s suppose your salary grew ten percent last year. This year, you get another ten percent more. The original was 1,000 USD. How much will you earn the end of this year? A wrong answer: 1,200 USD. The right answer: 1,210 USD. Why?

Compound interest and simple interest, by 10 percent interest rate.
Compound interest and simple interest, by 10 percent interest rate.

Because the second salary increase refers to the 1,100 USD already, not to the original 1,000 payment. (So, 1,000×1.1=1,100. Then, 1,100×1,1=1,210.) (I use x to indicate multiplication.) The second increase is projected to the raised amount. This happens also in the world of finances. For example, normally if you have 1,000 USD inverted in bonds or bank deposits with ten percent yearly interest (per annum, or p. a.). After one year you have 1,100, after two years, 1,210 dollars.

Interest on interests

That is called compound interest because the interest is given to the principal capital plus the previously accumulated interest(s). With other words of Wikipedia:

Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest. Compound interest is standard in finance and economics.

Why should you care?

OK, who cares, 10 USD is not a really big difference – can you say. In some cases you ‘re right. It depends on the period of time and the percentage of the interest. The lower interest rate doesn’t mean much difference, and short term either. But if long term or high rates apply, it can be important, relevant.

Compound interest and simple interest, by 1 percent interest rate.
Compound interest and simple interest, by 1 percent interest rate.

For example, in the case of a 10 percent rate, in ten years, the normal interest grows your capital to 1,900 USD. The compound interest, to 2,358. In 20 years, the difference is much larger, 2,900 USD versus 6,116. But in the second chart, I showed you the small difference compound interest makes in case of a small 1 percent interest. (Frequent in these times, with near-zero or zero interest rates in many countries.)


Compound interest and Steem

Some words about Steem pages and content. Before Hard Fork 21 (HF21) in August, may people used robots. After HF21, fewer Steemians are doing so. But let’s see the effect of this. Only the mathematics, nothing else.

Many robots were offering a positive ROI (return on investment, yield – similar to interest). If you gain ten percent in a week with robots, how high will be your yield on an annual basis? Very high, because of 1.1^52=142. (I use ^ to indicate exponentiation.) So, in theory, you could make 143-fold of your money in one year, with the yields re-inverted. With one dollar, you could make 142.

No more ROI on Steem

In reality, in the Steem system, only half of the money can be re-inverted, the other part stays “powered up” (staked, deposited) for weeks. But, let’s say, only half of your money brings this high yield. In this case, let’s calculate with a five percent yield on your total capital. So, 1.05^52=12.64. That means still, you can make 12.64 USD from an original 1 dollar in one year.

In theory. In reality, it is more complicated and the real yield could be higher. (Or lower, with downvotes.) Nowadays, robots pay no positive ROI.

Steem itself pays some interest-like income for people staking it (depositing, holding it in the form of “Steem Power”). Another income source is that 50 percent of votes (upvotes) value people make returns to the same upvoter. (See Steem FAQ.) But compared to the gains you could make with robots before, that incomes are very small. (I estimate 15-20 percent p. a.)

(I wrote here about compound interest before.)

Disclaimer

I’m not a certified financial advisor nor a certified financial analyst, accountant nor lawyer. The contents on my site and in my posts are for informational and entertainment purposes and reflecting my collection of data, ideas, opinions. Please, make your proper research, or consult your advisors before making any investment or financial or legal decisions.

(Cover photo: Pixabay.com)

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