Simple vs. Compound Interest in Calculating Reparations

Further to our discussion in class last week, on the calculation of reparations , here is the post on simple versus compound interest:

Understanding the difference between simple and compound interest is profoundly important - not only for purposes of calculating damages or reparations, but for one's own personal life. Here is a link to a spreadsheet that illustrates the power of compound interest. It includes the formulas you can use to calculate straight-forward compound interest.

Important to note is that an investment of $15,000 in an account earning compound interest, calculated and paid monthly, at a rate of 6% per annum, will earn $31,653.07 more in interest over a 20 year period, than an account earning simple interest at the same rate over the same period. Or to put it another way, the compound interest on a debt (and the interest on most debt is compounded), will be significantly more over time than simple interest. The problem is that many people think of interest, and do rough calculations of interest, in terms of simple interest rather than compound interest - and thus the power of compound interest can cause a lot of pain to the unsuspecting debtor.

Compound interest is even more powerful when the principal is increasing with each period. So, if you took $2 each week (the amount you might be tempted to spend on lottery tickets), and invested it in an account earning 6% per annum compounded monthly (admittedly impossible to find in the current environment), at the end of 40 years your account (in which you would have only invested $4,160 over the 40 years) would be worth $15,953, or close to four times your investment. Make that $20 instead of $2, and the amounts become more interesting.

You can find a straight compound interest calculator here, and one which includes the addition of monthly contributions to principal  here.