|Understand 'interest'. Then you
can understand the vital concept of 'return'
If you put £100 in cash in a deposit account at 6% per year you
will get back £106 after one year. The extra £6 is called
'the interest on the account' or just 'interest'. 6% is the 'interest
rate', and may be described as 'annual interest' or '6% per annum'
- 'per annum' meaning the same as 'per year'.
Interest over shorter periods
It may be that interest is paid on the account each 6 months. In
that case it might be described as 'interest at 3% half-yearly'.
The word 'interest' does not mean anything without a period attached.
If no period is mentioned it is assumed to be annual.
'Simple' here does not mean 'easy'. It is a technical term describing
how interest is added to an account.
On your £100 deposit, 6% simple interest adds
£6 to the account after one year, another £6 (making
a total of twelve) after two years......a total of £30 after
five years, £36 after six years........£60 after 10
years, and so on. The total in the account after 10 years is £160.
Simple interest is almost never used outside exams
in Arithmetic. It's just a precursor to...
In real life, the £6 you earn on your £100 account is
added to the balance to give an opening balance of £106 at
the start of year 2. Your friendly bank will then calculate your
6% interest in year 2 on £106, giving £6.36. The interest
you have earned over two years is not £12 but £12.36.
This is described as '6% compound interest' or 'interest at 6% compounded
annually over two years'.
In case you are bored by this, we will tell you that;
- 6% simple interest over 20 years gives you
120% - £220 from every initial £100.
- 6% compond interest over 20 years gives you
221%- £321 from every initial £100.
Quite a difference! More on this later.
Interest compounded over shorter
If interest is compounded half-yearly, the interest after 6 months
is £3 and the interest in the second 6 months is 3% of £103,
or £3.09. You can calculate that the interest in the third
and fourth periods is £3.18 and £3.28 - a 2-year total
A cash deposit is quite a simple investment.
For more complicated investments we use the word 'return' instead
of the word 'interest'.
|Learn about 'Return' now: