As a kid, I never understood why a seemingly arbitrary and unwritten rule stipulated that compound interest would apply daily. That is, if you were asked to calculate compound interest over the course of a year, the interest accrued would become part of the principal sum at the end of each day. I never understood why it shouldn’t apply every hour, minute or second.
Below is the effect of differing frequencies with which the principal sum is topped up, each on an initial principal sum of 10,000 and a compound interest rate of 20%. The figures show the resulting sum after one year of investment.
- Annually (i.e. simple): 12,000
- Quarterly: 12,155.06
- Monthly: 12,193.91
- Weekly: 12,209.36
- Daily: 12,213.36
- Hourly: 12,214.00
- Every minute: 12,214.03
- Every second: 12,214.03.
I guess for the sake of threepence, I needn’t have worried.