Question

Emily Murphy plans to invest RM1,000 extra incomes she earns for her consumption in the next 10 years. She has two different option of investment. The first option is to deposit the money into a saving account that pays 10% annual simple interest for the next 10 years. While the second option is to put the money into a retirement account that pays 10% compounded interest annually for the same period of time. Which option will provide the highest future value to Emily at the end of 10th year? Complete the table below to assist Emily in choosing the highest investment return in 10 years. Year Option 1 (Simple Interest) Option 2 (Compound Interest) 1 2 3 4 5 6 7 8 9 10 Interest Rate 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%

Answer 1

Answer

It would be better to invest in option 2 as interest earned during 10 years is more than Total interest earned in option 1 of simple interest. This is because in option 2 interest is compounded.

Interest under simple Interest Method = Initial Principal * Rate of Interest*time Period (Time Period = One Year)

Interest under Compound Interest Method = Principal * (1+rate of interest)^time Period (Here principal = Initial amount + Interest accrued till Date)

The calculations are shown in the table

Amount Invested Rate of Return time period Compounding in a year Simple Interest Compound Interest 1000 1000 10% 10% 101 100 1 Year Formula 2 Option 1 (Simple Option 2 (Compound Interest Rate Interst) Interst) (Principal*RATE) (Principal+interest)*rate 1 10% 100 100 10% 100 1101 3 10% 100 121.00 4 10% 100 133.10 5 10% 100 146.41 6 10% 100 161.05 7 10% 100 177.16 8 10% 100 194.87 9 10% 100 214.36 10 10% 100 235.79 Total Interest 1000 1593.74