What is Compound Interest?
Compound interest is the interest calculated on the initial principal, which also includes all the accumulated interest from previous periods. This means you earn interest on both your original investment and on the interest that investment has already earned.
How Does Compound Interest Work?
With compound interest, your money grows faster compared to simple interest, because you earn interest on your interest. The more frequently interest is compounded, the greater the amount of interest you will earn.
Compound Interest Formula
Formula:
A = P (1 + r/n)nt
- A = Final amount
- P = Principal (initial investment)
- r = Annual interest rate (decimal)
- n = Number of times interest is compounded per year
- t = Number of years
Example Calculation
Suppose you invest ₹10,000 at an annual interest rate of 8%, compounded yearly, for 5 years:
- P = ₹10,000
- r = 8% = 0.08
- n = 1
- t = 5
Calculation:
A = 10,000 × (1 + 0.08/1)1×5 = 10,000 × (1.08)5 ≈ ₹14,693.28
Interest earned: ₹14,693.28 - ₹10,000 = ₹4,693.28
Benefits of Compound Interest
- Accelerates the growth of your savings and investments
- Rewards long-term investing
- Helps achieve financial goals faster
- Works best when you start early and invest regularly
Frequently Asked Questions (FAQs)
The more frequently interest is compounded (monthly, quarterly, yearly), the more you earn.
Simple interest is calculated only on the principal, while compound interest is calculated on the principal plus accumulated interest.
Yes, the compound interest formula applies to both investments and loans.