Question

Let's say that you are interested in opening an inverstment account that you will keep for at least 20 years. Compare the future values of that account using simple interest and compound interest if the interest rate is 2.6% and is compounded annually. Which type of interest (simple or compound) would you choose for your investment and why?

Answer 1

• over 20 years, the value of the compound interest account is about 10% more
• my choice is the compound interest account because of its higher earnings

Explanation:

For principal amount P, the future value of the simple interest account will be ...

P(1 + rt) = P(1 + .026·20) = 1.52P

The future value of the compound interest account will be ...

P(1 +r)^t = P(1.026^20) ≈ 1.6708875P

The value of the compound interest account is about 10% greater after 20 years.

I would choose the compound interest account because it has a higher rate of return.