Difference Between Simple and Compound Interest

The basic difference between simple and compound interest is that the simple interest is only calculated on the principal amount and does not contain the accumulated interest from prior periods. On the other hand compound interest is known as the interest on interest. Basically it is calculated both on the principal amount as well as the accumulated interest in the prior periods. The difference between simple and compound interest could be elaborated with the help of simple problems.

 

Simple interest

 

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Compound interest on interest

 

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At the end of fifth year, in simple interest total amount will be 1400. In this case $1000 is the initial investment and $400 is the interest earned. In compound interest at the end of 5th year the total amount grows to 1469.33 which clearly shows that compound interest gives higher return on investment than the simple interest. It means that the simple interest is just the interest earned on initial investment whereas compound is interest on interest.

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