Kamola runs a small bakery in Tashkent and had saved 10 million sum for a new oven. She did not need the oven for three years, so she visited two banks to deposit the money.
The first bank offered 10 percent simple interest a year. Each year she would receive one million sum, always calculated on her original deposit. After three years she would have earned three million sum in interest.
The second bank also offered 10 percent, but compounded annually. The bank clerk explained the difference with a pencil. In the first year, the interest is one million, just as in the first bank. In the second year, however, the interest is calculated on 11 million, so it comes to one million one hundred thousand. In the third year it is calculated on 12 million one hundred thousand, which gives one million two hundred and ten thousand.
Kamola added the three years together: one million, plus one million one hundred thousand, plus one million two hundred and ten thousand. The total interest was three million three hundred and ten thousand sum, which was 310 thousand more than at the first bank.
"It is the same rate," she said, "so why is it more?" The clerk smiled. "Because in the second and third years, your interest also earns interest."
Kamola chose the second bank. She also noticed something the clerk had not said: the extra money grew faster every year. Over three years the difference was small, but over ten or twenty years it would become large. She wrote the rule in her notebook: when two offers have the same rate, read the next word. Simple means the interest stands still; compound means it grows.
Three years later, the oven cost a little more than she had planned, and the extra interest covered most of the price rise.