Understanding Compound Interest

Are you familiar with compound interest? It is a financial concept that can play a key role in growing your savings over time. That is why Enerfip is talking about it today! In this article, we explain what it is, how it differs from simple interest, and how to calculate it.

Simple Interest: What Is It?

Simple interest, unlike compound interest, consists solely of the amount your invested capital earns each year.

Example

If you invest €1,000 in a hypothetical product at 5% annual interest, you would earn €50 in interest, which would be added to the initial capital.

Each year, the process remains the same: you receive €50 in interest until the end of the investment term.

Compound Interest: What Is It?

Before going further, let us clarify the concept of compound interest. Also known as capitalised interest or cumulative interest, it represents the gain obtained when the interest generated on a capital sum is reinvested to in turn produce further interest.

Compound interest allows capital to grow progressively and thus maximises returns over the long term. In short, this principle illustrates the growth potential of money that is placed or invested, generating interest that is directly reinvested. In a way, it is a snowball effect, based on a capitalisation technique. It is a mechanism of exponential capital accumulation, favouring rapid growth of your investment over the long term.

Example

If you invest €1,000 at 5% per year for 3 years:

• In the first year, you would earn €50 in interest;
• In the second year, you would have €1,050 at 5%. You would therefore earn €52.50 in interest;
• In the third year, you would receive an additional €55.10 on top of the €1,102.50, which corresponds to the initial capital plus the interest from previous years.

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As you can see, the interest earned increases each year.

The Compound Interest Formula

When dealing with compound interest, a calculation is required. To calculate compound interest over long periods, the following formula is used: C0 x (1 + i)^n = Cn. At first glance, it may seem complex. However, it is straightforward once you have the keys to understanding it.

• C0 corresponds to the initial capital amount, i.e. the money you initially invested in the financial product.
• The bracket (1 + i) refers to one year including the expected interest based on the return, where i is the interest rate per period.
• The exponent "n" is the number of years the investment lasts.
• Cn is the final sum.

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Example

You decide to invest €10,000 in a hypothetical product at 10% for 5 years. To calculate the compound interest, you must perform the following calculation: 10,000 x (1 + 10%)^5 = €16,105.

To summarise:

• Your initial capital is €10,000;
• Your interest would amount to €6,105, broken down as follows:
  • Year 1: €10,000 x 10% = €1,000 in interest, giving a capital of €11,000;
  • Year 2: €11,000 x 10% = €1,100 in interest, giving a capital of €12,100;
  • Year 3: €12,100 x 10% = €1,210 in interest, giving a capital of €13,310;
  • Year 4: €13,310 x 10% = €1,331 in interest, giving a capital of €14,641;
  • Year 5: €14,641 x 10% = €1,464 in interest, giving a capital of €16,105.

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Although Enerfip primarily offers simple interest, it is possible to receive compound interest depending on the project profile. For any questions or if you need guidance, our Investor Relations team is available by phone at +33 4 11 934 11, by email at [email protected], or online by booking an appointment on our website.