Interest Question

[Gotera]

Upon doing light reading and research on simple and compound interest, I do not find much reason to not be using compound over simple. For what reasons would a person use simple interest? What are the pros and cons of choosing simple interest over compound?

[sokoloff]

Basically any time where there’s only one payment, simple interest and compound are the same.

A short-term CD or a discount for early payment of an invoice (net-30, 1%-10) are examples where there’s only one chance to apply interest (no interest on interest) so simple and compound are the same.

Most anything multi-period is compounded.

[radram]

Plus there are investments where compound interest just is not possible. As an example, that $5,000 minimum CD you buy will not generate enough interest to purchase another CD.

[NorthernBlitz]

Basically any time where there’s only one payment, simple interest and compound are the same.

A short-term CD or a discount for early payment of an invoice (net-30, 1%-10) are examples where there’s only one chance to apply interest (no interest on interest) so simple and compound are the same.

Most anything multi-period is compounded.

This.

The formulas are the same, but simple interest only has N=1 time periods.

The beauty of compounding begins in the second time period if you reinvest the first interest payment. In that case, you get paid interest on the original principle AND a bit of "extra interest" for the reinvested first interest payment you received. This gets more powerful as N increases.