Compound Interest Explained in One Minute

Summary

The script compares the investment strategies of John and Lisa, who both invest $1,000 at a 10% annual interest rate. John withdraws his $100 interest each year, leaving him with $4,000 after 30 years. Lisa reinvests her interest, earning compound interest, and accumulates $17,449.40, illustrating the power of compounding over time.

Takeaways

• 🏦 John and Lisa both invest $1,000 in a bank offering a 10% annual return.
• 💸 John withdraws the interest each year, leaving his principal intact.
• 💰 Lisa reinvests her interest, allowing it to compound over 30 years.
• 🔢 After one year, John has $1,100, taking out $100 interest, leaving $1,000 principal.
• 📈 Lisa's account grows to $1,100 after one year, without withdrawing interest.
• 📊 In subsequent years, Lisa earns interest on the accumulated amount, not just the initial principal.
• 💲 By the 30th year, Lisa's account has grown to $17,449.40, significantly more than John's.
• 📉 John's account remains at $1,100 each year, taking out $100 interest, ending with $4,000 total after 30 years.
• 📚 The power of compounding is evident as Lisa's investment grows four times more than John's.
• 💡 The example illustrates the importance of reinvesting interest for long-term financial growth.

Q & A

What is the annual interest rate offered by the bank in the script?

The bank offers an annual interest rate of 10%.

How much does John invest in the bank?

John invests $1,000, which is referred to as the principal.

What does John choose to do with the interest earned each year?

John chooses to spend the interest each year and keeps only the principal in the bank.

How much interest does John earn in the first year?

John earns $100 in interest in the first year, which is 10% of his $1,000 principal.

How much money does John have in his account after 30 years if he withdraws the interest each year?

After 30 years, John will have $4,000 in total, which includes his initial principal of $1,000 and the interest of $100 per year for 30 years.

What is Lisa's investment strategy compared to John's?

Lisa chooses to save for 30 years without withdrawing the interest, allowing it to compound annually.

How does the interest earned by Lisa differ from John's after the first year?

After the first year, Lisa earns interest not only on her initial $1,000 but also on the interest earned in the first year, resulting in more than $100 for the second year.

What is the formula for calculating the amount in Lisa's account after each year?

The amount in Lisa's account after each year is calculated by taking the previous year's total and adding 10% of that total.

How much does Lisa have in her account after 30 years?

After 30 years, Lisa has $17,449.40 in her account.

What is the difference in the final amount between John and Lisa after 30 years?

After 30 years, Lisa has over four times more money than John, with $17,449.40 compared to John's $4,000.

What is the key concept illustrated by the difference in the final amounts between John and Lisa?

The key concept illustrated is the power of compound interest, where reinvesting the interest can lead to significantly higher returns over time compared to withdrawing it annually.

Outlines

00:00

💼 Investment and Interest Calculation

The paragraph discusses a scenario where John and Lisa each invest $1,000 in a bank offering a 10% annual return. John chooses to withdraw the interest each year, leaving his principal intact, while Lisa allows her investment to compound over 30 years. John's account grows to $1,100 each year, from which he withdraws $100 annually, resulting in a total of $4,000 after 30 years, including his principal. Lisa's account compounds, meaning each year she earns interest on the accumulated amount, not just the initial principal. After one year, she has $1,100, and by the end of the 30th year, her account has grown to $1,749.40, which is significantly more than John's due to the power of compound interest.

Keywords

💡Bank

A bank is a financial institution that accepts deposits, extends credit, and provides a variety of other financial services. In the context of the video, the bank is offering a generous 10% annual return on investment, which is the basis for the financial scenarios presented for John and Lisa.

💡Return

Return in finance refers to the profit or loss derived from investing or saving money. In the video, the return is the 10% annual interest paid by the bank on the principal amount invested by John and Lisa.

💡Principal

The principal is the initial amount of money invested or borrowed. In the script, both John and Lisa each invest $1,000 as their principal, which is the base amount on which the bank calculates the interest.

💡Interest

Interest is the cost or fee paid for borrowing money, or the earnings or profit from saving or investing money. In the video, the bank pays 10% interest annually on the principal, which John withdraws each year, while Lisa allows it to compound.

💡Compound Interest

Compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. Lisa's strategy of reinvesting her interest each year exemplifies compound interest, which leads to her having significantly more money than John after 30 years.

💡Invest

To invest means to allocate money with the expectation of earning a return or profit. John and Lisa both invest $1,000 each in the bank, but they have different strategies for managing their returns.

💡Spend

Spending is the act of using money to purchase goods or services. John chooses to spend his interest each year, which means he does not benefit from compounding interest and only retains his original principal amount.

💡Save

Saving is the act of setting aside money for future use. Lisa's decision to save her interest each year, rather than spending it, allows her to benefit from the power of compound interest.

💡Annual

Annual refers to something that occurs or is considered once each year. The bank offers an annual return of 10%, which is calculated and potentially added to the principal once a year.

💡Account

An account is a record of financial transactions, such as those held at a bank. In the script, John and Lisa both have accounts with the bank where their principal and interest are recorded.

💡Year

A year is a unit of time, typically used in finance to measure periods such as investment terms. The script discusses the outcomes of John and Lisa's investment strategies over a period of 30 years, emphasizing the long-term effects of their choices.

Highlights

Bank offers a generous 10% annual return on investment.

John and Lisa each invest $1,000 as principal.

John spends the interest each year, keeping only the principal in the bank.

Lisa saves for 30 years without withdrawing the interest.

John earns $100 interest per year, totaling $3,000 over 30 years.

After 30 years, John's total account balance is $4,000.

Lisa's account grows annually with compound interest.

After one year, Lisa's account has $1,100.

In the second year, Lisa earns interest on $1,100, totaling $1,210.

By the third year, Lisa's account grows to $1,331.

After 30 years, Lisa's account reaches $17,449.40.

Lisa's final account balance is over four times more than John's.

The power of compound interest is demonstrated in Lisa's investment strategy.

John's strategy results in a total return of 100% over 30 years.

Lisa's strategy results in a total return of 644.94% over 30 years.

The importance of reinvesting interest for long-term growth is highlighted.

A clear comparison between spending interest and reinvesting it for compound growth.

The transcript illustrates the long-term benefits of saving over spending.

Transcripts

let's assume a very generous Bank offers

to pay John and Lisa a return of 10% per

year and they each invest $1,000 called

the principal john wants to spend the

interest each year and only keep the

principal in the bank while Lisa wants

to save for 30 years so she doesn't take

the interest out each year in John's

case the 10% amount to $100 each year so

after one year he'll have eleven hundred

dollars in his account out of which

he'll take a hundred dollars after the

second year he'll once again have eleven

hundred dollars in his account out of

which he'll take a hundred dollars after

the thirtieth year he'll have eleven

hundred dollars as usual and take $100

he will be left with a thousand dollars

in his account so his principal and the

returns he made amount to a hundred

dollars multiplied by 30 so another

three thousand dollars a grand total of

four thousand dollars that he made over

30 years Lisa on the other hand will

make more after one year she will have

eleven hundred dollars in her account

but she keeps everything there after the

second year she will earn 10% of those

eleven hundred dollars and not only on

the initial one thousand dollars

therefore she will have eleven hundred

dollars plus one hundred and ten dollars

so twelve hundred and ten dollars after

the third year she will earn 10% of

those one thousand two hundred ten

dollars and have one thousand three

hundred and thirty one dollars after

year thirty she will have seventeen

thousand four hundred and forty nine

dollars and forty cents over four times

more than John