The Logic and Mathematics of Non-Annual Compounding Applied to Investment Decisions

Abstract

Many of us have grown so used to living with compound interest that we have forgotten its underlying principles. In particular, those of us who deal in long-term investment decisions often grow too accustomed to the simplifying assumption of annual compounding. When confronted with situations in which non-annual compounding must be understood, we often find ourselves confused. All of us tend to be too unthinking about the mathematics of compound interest. The purpose of this paper is to stimulate clear thinking about non-annual compounding and to suggest when and where its application may be worth the trouble.