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One simple financial question to ask yourself and colleagues:
“If you had a choice, would you rather receive $200,000 cash or a penny that doubles in value every day?”
Not surprisingly, most people choose the $200,000. It is the bird in the hand concept.
But in reality, the magical penny would actually leave individuals much better off. Due to the magic of compound interest, a penny that doubles in value every day would be worth more than $10 million after only a month!
The compound interest equation which follows applies:
FV = PV(1+r)n, where FV is future value, PV is present value, r is the interest rate per period, and n is the number of compounding periods.
Compounding is the effect where an investment earns interest not only on the principal component but also gives interest on interest. So compounding is basically interest on interest. When we say that the investment will be compounded daily, it means that we will earn interest on the daily interest along with the principal.
The concept is such that it assumes that the interest earned every day is reinvested at the same rate and will get increased as the time passes.