How does a low interest rate impact the power of compounding over time?

• A. It increases the compounding effect, causing investments to grow much faster.
• B. It causes the principal amount to decrease over time.
• C. It has no impact on the compounding process.
• D. It reduces the overall effect of compounding, resulting in slower growth of invested funds.

Answer: (D)

Verified step by step guidance

1. Understand the concept of compounding: Compounding refers to the process where the interest earned on an investment is reinvested, allowing the investment to grow exponentially over time. The rate of growth depends on the interest rate applied.
2. Analyze the impact of a low interest rate: A lower interest rate means that the amount of interest earned on the principal and subsequent reinvested interest is smaller, which slows down the compounding effect.
3. Compare scenarios: Consider two investments, one with a high interest rate and one with a low interest rate. Over time, the investment with the higher interest rate will grow faster due to the larger compounding effect, while the investment with the lower interest rate will grow more slowly.
4. Relate to the given options: The correct answer aligns with the principle that a low interest rate reduces the overall effect of compounding, resulting in slower growth of invested funds.
5. Conclude the explanation: The power of compounding is directly influenced by the interest rate. A lower interest rate diminishes the compounding effect, leading to slower accumulation of wealth over time.