Question

At approximately what rate would you have to invest a lump-sum amount today if you need the amount to double in 27 months? Assume interest is compounded annually.

Select one:

a. 20%

b. 12%

c. 36%

d. Not enough information is provided to answer the question.

e. 24%

Answer 1

What is the Power of Compounding??

When the principal includes the accumulated interest of the previous periods and interest is calculated on this then they say its compound interest. This powerful tool (compound interest) can be used by investors to plan their financial goals. In the long term, this technique will benefit the investor. Longer, the investment horizon higher are the returns. The right advice is to start saving regularly and invest wisely. An early start would give the investor a higher compounding effect, and building wealth becomes easy. The possibilities of the compound interest are endless. With time, compound interest only further enhances the earnings, and the investment grows manifold.

Compound interest can be calculated by:

• Daily compounding
• Monthly compounding
• Quarterly compounding
• Half-yearly compounding
• Yearly compounding

Compounding is done on loans, deposits and investments. Frequency of compounding is basically the number of times the interest is calculated in a year. The higher the frequency of compounding, the greater the amount of compound interest. The frequency of compounding depends on the instrument. A credit card loan is usually compounded monthly and a savings bank account is compounded daily. The frequency of compounding varies based on the scheme offered by the bank or financial institutions.

One doesn't have to be a financial analyst to understand the concept of compounding. To make the maximum advantage of the compound interest, invest a small amount regularly for long periods of time. Use the compound interest calculator to see how the magic unfolds with time. Compounding is a technique that makes money work harder. An average investor depends on this tool to plan for their financial goals. Most long term financial goals become easier and achievable because of the power of compounding .

For example, INR 100 is invested, and the compound interest rate is 6% p.a. The principal amount is INR 100, and the interest earned at the end of 1 year is INR 6 (6% of INR 100). Instead of withdrawing the interest amount, it is reinvested, then the principal amount for the second year becomes INR 106 (INR 100 + INR 6). The interest earned for the second year is INR 6.36, this is 0.36 more than the previous year. Even though the amounts look very small, it makes a huge difference in the long term. The magic of compounding works only over long periods of time.