What is Effective Interest Rate?
You may notice the factsheet for our business term financing notes may state both the simple interest rate and effective interest rate. “Interest rate” is the rate of interest that is agreed by the issuer to be paid to investors in return for the financing given over a financing tenure without considering re-investments of the repayments.
The “Effective Interest Rate” on the other hand, indicates the rate of potential returns higher than simple interest rate (effective interest rate 18% p.a. vs simple interest rate 10%) when the monthly repayments of principal and interest are being re-invested, and the effect of compounding takes place.
The Power of Compounding Effect
With the concept of the compounding effect, investors can potentially earn much higher returns than expected. Not only investors may earn interest on the principal, but the investors may also earn interests on top of interests, like a snowballing growth effect to bring in more returns.
How to enjoy an effective interest rate in P2P investment?
In P2P investment, investors may simply reinvest the monthly repayments to more investment notes in order to maximize the returns and be able to let the money compounds in return on a monthly basis.
In order to understand the concept more clearly, please refer to our illustration below on the different approaches taken by Investor A and Investor B on their investments.
Investor A – Simple Interest Rate without Reinvestment
Investment Capital: RM10,000
Interest Rate: 12% p.a
Tenure: 12 months
Expected Return on Interest: RM1,200
Investor A invests RM10,000 into a single note with an interest rate of 12% p.a for a period of 12 months. Investor A may expect to earn RM1,200 in interest for this note with a full repayment without default. Without any form of reinvestment, the returns remain as 12% p.a as there is no compounding effect
Investor B – Effective Interest Rate with Reinvestment
Investment Capital: RM10,000
Simple Interest Rate: 12% p.a.
Effective Interest Rate: 20.54%*
Tenure: 12 months
Expected Return on Interest: RM 2,054.61*
Instead of investing on the same investment note or withdrawing the profit or interest earned, Investor B continues to reinvest his monthly returns into other Issuer/Investment Note.
Based on the chart above, when Investor B receives the interest earned of RM100 from Investment Note 1, he reinvests the first repayment of RM 933.33 into a second investment note which provides the same interest rate of 12% p.a. to generate more interests.
In the second month, Investor B receives RM 177.77 principal and RM100 interest earned from Investment 1 with additional interest earned of RM9.33 from Investment 2. Investor B continues to reinvest the repayment into Investment Note 3 which provides the same interest rate of 12% p.a. By continuing to reinvest the repayment accumulated from Investment Note 1, Investor B may expect to earn an interest rate from 12% p.a. up to an estimated 20.54% p.a. effective return.
By comparing the 2 approaches taken by Investor A and Investor B, Investor B is more likely to benefit more from the effective returns due to the reinvestment from the interest earned. We are able to see a constant increase in the money value from Investor B investment profile due to compounding effects.
Business Term Financing provides monthly repayment
In Funding Societies, Business Term Financing allows Investors to reinvest their monthly repayment into another available investment note and further grows the money by providing monthly repayment for investors.
We have an average of 50 to 60 Business Term Financing investment notes available every month for our investors to invest (though this number could be different during the Movement Control Order period). This is to provide opportunities for investors to reinvest into available notes that provide the same interest rate to enjoy the power of the compounding effect and earn effective returns.
With the reinvestment approach, investors have the potential to earn higher returns even if there are some missed repayments in some period of time.
The key to earning effective returns
The best timing to start investing is now. An advantage of investing earlier is the ability to take advantage of the compounding effects and let the money do the work for us. All we need to do is to make investing part of the habit now and be consistent in reinvesting the principal and interest over time.
Still, wondering when is the best time for you to start investing? Start your investment with Funding Societies NOW with a minimum amount of RM100. Click here to invest.
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Disclaimer: The information provided to you in this blog post is intended only for general information purposes only and does not constitute legal or other professional advice on any subject matter. The materials and the information provided are not intended to be and do not constitute an advertisement or solicitation. In no event will Funding Societies be liable to any party for any direct, indirect, incidental, special, consequential or punitive damages for use of such information by you or any unauthorized third party