I'm attempting to out a mini version of each explainer out on Racket, a mini-podcast platform whose mobile app only allows me to record 99 seconds of audio. My goal here is to force myself to distill a topic down even further into a maximum of 99 seconds of verbal content.
TRANSCRIPT:
As a Product Manager I need to ship. So my first Racket was my MVP, think of this one as V2 of the same release. We're talking about compound interest.
What is it - Compounding interest is essentially interest on interest.
When we earn normal interest, or "simple interest", we earn a given % on our investment each period of time.
For example if we earn 5% simple annual interest on an investment of $1000 we will earn $50 in year 1. $50 in year 2 and so on.
The idea behind compound interest is that we take that $50 each year and reinvest it. This way we start year 2 with $1050 and earn 5% on that, so $52.50. We then put that $52.50 back in to earn interest on itself so in year 3 we earn $55.13.
The thing about compound interest is that it doesn't look like much at first, but makes a big difference in the long term.
In our example, with simple interest, after 10 years (so in year 11) we still earn $50 in interest.
With compound interest, we earn $81.45 in interest.
Let's extend this out to 25 years and see what happens.
In year 25 years simple interest is still delivering $50.
Whereas our compounding investment is delivering $161.25 in the same year. Now you're earning 16% on the original investment of $1000 just because you reinvested the interest over time instead of taking it out.