Microsoft Office Tutorials and References

In Depth Information

For example, suppose that you deposit $5,000 into a three-year CD with a 4.25% annual interest rate compoun-

ded quarterly. In this case, the investment has four compounding periods per year, so you enter
4
into cell B6.

The term is three years, so you enter
3
into cell B7. The formula in B10 returns
$5,676.11
.

Perhaps you want to see how this rate stacks up against another account that offers daily compounding. Figure

11-10 shows a calculation with daily compounding, using a $5,000 investment (compare this with Figure 11-9).

As you can see, the difference is very small ($679.88 versus $676.11). Over a period of three years, the account

with daily compounding earns a total of $3.77 more interest. In terms of annual yield, quarterly compounding

earns 4.51%, and daily compounding earns 4.53%.

Figure 11-10:
Calculating interest by using daily compounding.

The Rule of 72

Need to make an investment decision but don't have a computer handy? You can use the Rule of 72 to determine

the number of years required to double your money at a particular interest rate, using annual compounding. Just

divide 72 by the interest rate. For example, consider a $10,000 investment at 4% interest. How many years will it

take to turn that 10 grand into 20 grand? Take 72, divide it by 4, and you get 18 years. What if you can get a 5%

interest rate? If so, you can double your money in a little over 14 years.

How accurate is the Rule of 72? The table that follows shows Rule of 72 estimated years versus the actual years

for various interest rates. As you can see, this simple rule is remarkably accurate. However, for interest rates that

exceed 30%, the accuracy drops off considerably.