Compounding is when you earn interest on your investment over a period of time, due to which you witness a growth on your earnings. Power of compounding enables your earnings to grow as your investments grow. Here's how you can understand this better. An interest is added on the initial investment (principal amount), this interest is the compound interest.Read More Since the amount would be added to the initial investment and the new interest is calculated on this amount, the investment will continue to grow as this process would be consistent all throughout the investment period.Read Less
Compound Interest Calculator
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Frequently Asked Questions
How to use the Compound Interest Calculator?
If you’re wondering what kind of interest rate you need, you can check out our compound interest calculator. To start, you need to know how much money you have to invest upfront. Input this number in the given box. Next, if you’d like to add more money to your investment at regular intervals, you can choose to do so. Type in the amount you’d like to add and choose whether they will be monthly or annual payments. Next, decide how many years you’d like to invest for. Will you be making the regular payments for 5 years, 10 years or 25 years? You can either move the slider or simply input the number of years in the provided box. Once you’re done putting money in your investment, you can choose to remain invested for a longer time. This means that your interest will continue to compound and your money will grow over time. When selecting the number of years you’d like to stay invested for, it’s important that it’s more than the number of years that you want to invest for. Again, you can either move the slider or input the number directly in the provided box. If you have an understanding of how much money you would like at the end of the investment term, you can check the graph on the right-hand side of the page. As you change the rate of interest, either by shifting the slider or inputting numbers in the box, you’ll see how much money you can expect to earn at the end of your investment term. This will give you a clear indication of what is the best rate of interest for you to choose based on your investment capabilities, the amount of time you want to invest for and the amount of money you hope to have at the end of the investment.
What Is Daily, Monthly & Early Compounding?
When it comes to choosing between simple and compound interest, compound interest will always win. But, there’s a way that you can make compound interest work harder for you. When you’re choosing an investment avenue that offers compound interest, you can also look at how often the interest is compounded. You can choose plans where the interest is accrued daily, monthly, six-monthly or annually. Compounding will always work best when the interval of compounding is short. We can understand this better with an example.
Let’s say Mr A has made an investment of INR 10,000 for just 3 years at a rate of 7%. If the interest is compounded annually, he’ll end up with INR 12,250 at the end of 3 years. If the compounding was done on a half-yearly basis, he would end up with INR 12,314 and if it was done on a monthly basis, he’d end up with INR 12,293.
You can also opt for daily interest accrual, which means your interest will be compounded every single day. So, every day you will earn a new amount based on the interest added to your initial investment. To maximise the benefit you can enjoy from a compound interest investment, it’s crucial that you start saving and investing as quickly as possible. The more time your money has to compound and grow, the more you will end up with.
What Are Compound Interest Investments?
When it comes to investing, it’s always a good idea to choose an investment avenue that allows you to enjoy compounded interest. This is the most efficient way to maximise your returns and get the most out of your money. There are a number of investment opportunities today where you can benefit from plans that compound interest at regular intervals. At the most basic level, banks offer compound interest. The interest you earn every 6 months is added to your savings, and for the next six month, you can earn interest on the new amount. But this is hardly enough to help you achieve your financial goals. Mutual funds and Unit-Linked Insurance Plans (ULIPs) are two of the most common investments that utilise compound interest formulae to grow your money. Both investment avenues work in a similar fashion, with the main difference being that ULIPs offer the additional benefit of life cover. Compound interest investment plans are especially useful in planning your finances for your retirement.
What is compound interest?
The interest on a loan or deposit calculated based on the initial principal, and the collective interest from previous periods is called compound interest. It is basically 'interest earned on money that was previously earned as interest'. This allows your sum and interest to grow at a faster rate compared to the simple interest which is calculated only on the principal amount.
The rate at which compound interest accumulates interest depends on the frequency - higher the number of compounding periods, higher will be the compound interest. For instance, if you earn a 10% annual interest, a deposit of Rs 100 would gain you Rs 10 after a year. What happens the following year? That’s where the compound interest comes in. You’ll earn interest on your deposit, and you will also earn interest on the interest you just earned.
The longer you leave your money untouched, the greater it will grow because compound interest grows over time which means your money keeps on multiplying over a period of time. If you are repaying a loan on compound interest, you should not ignore paying the interest or if there is any delay in paying the loan, then the interest burden will be high. To take advantage of compounding, one must aim at increasing their frequency of loan payments. This way you can pay less interest than what you are liable to pay.
Since the interest-on-interest effect can generate positive returns based on the initial principal amount, it has sometimes been referred to as the snowball effect of compound interest.
What is the formula for Compound interest?
You can calculate compound interest with a simple formula. It is calculated by multiplying the first principal amount by one and adding the annual interest rate raised to the number of compound periods subtract one. The total initial amount of your loan is then subtracted from the resulting value.
Compound Interest = Total amount of Principal and Interest in future (or Future Value) less Principal amount at present (or Present Value)
Compound Interest = P [(1 + i) n – 1]
P is principal, I is the interest rate, n is the number of compounding periods.
An investment of Rs 1,00,000 at a 12% rate of return for 5 years compounded annually will be Rs 1,76,234. From the graph below we can see how an investment of Rs 1,00,000 has grown in 5 years.
In compound interest, one earns interest on interest. Therefore, it already takes into consideration all the previous interests. And interest is paid on that.
By understanding how compound interest works and acting on it by investing in the right set of investments, you can achieve high returns.
What is the difference between simple interest and compound interest?
Simple interest is applicable for money borrowed for a fixed period of time. While compound interest is applicable whenever the interest is up for payment it will be added back to the principal amount.
Below are the top differences between Simple Interest and Compound Interest:
Basis of comparison
It is the interest on the total principal amount.
It is the interest which is a % of both principal and accumulated interest.
Return for lender
The simple interest offers low returns.
The compound interest offers a comparatively high return.
The principal is constant for simple interest.
The principal keeps changing due to the addition of accumulated interest during the period.
Principal and interest growth is constant.
Principal and interest growth is quick that increases at a fast pace.
Interest is charged on the principal amount only.
Interest is charged on the principal amount and also on the interest amount.
P * (1 + R) ^ NK
Calculation of simple interest is very easy and easy to understand.
The interest calculation of compound interest is a little difficult comparatively as it involves different periods of compounding.
Simple interest is better when buying something like a car loan which is calculated based on simple interest.
Compound interest is useful when it comes to investing. Since it allows the fund to grow quickly.
How does compound interest work?
If you make a sound investment, compound interest can help you to build your wealth over time. But if your debt is subjected to compound interest, then it can cause financial hardship if not planned. To understand how compound interest works, let us break down the process of how your investment can compound better.
Compound Interest starts when your investment earns interest. At this point, the interest is added to the initial investment amount. When it earns interest again, it will determine the newly earned interest by calculating the initial capital invested and the earned interest.
As the size of the investment continues to grow, it will earn interest to the total investment amount. This loop will continue allowing the investment to grow substantially without any additional investment capital. With time, this cycle has potential for a substantial growth of the original investment.
Here are the two factors that will have an impact on your compound interest returns:
1) Time - You need to allow your investments to grow with time, the more time you enable, the more growth you will see.
2) The rate of interest - A higher rate of interest will generate higher balance when compounding the investment.
You can decide your investment priorities and goals, keeping in mind the various scenarios & avenues and how it will impact your life.
The bottom line is that if you are able to harness the advantage of compound interest then it can work wonders for your investment plan and financial goals.
Advantage of compound interest
If you are concerned about not being able to save enough for your child's education or retirement, then why not pick an investment avenue with compound interest? It has the potential to grow your wealth and anyone can take advantage of the many benefits as listed below:.
- You can earn interest on both the money you have saved and on the interest that money earns. For instance, If you invest Rs 5000 and receive 5% annual compound interest, at the end of the year you will have Rs 5,250 in your account. In your second year, interest will be calculated on Rs 5,250 and with every passing year, the amount accumulated will have the interest paid on the balance and grow your wealth.
- The longer money sits in a compound interest account, the more benefit you will reap over the long term. A difference of even 1% in the interest rate will increase your capital gains.
- With inflation, the costs of services and goods increase gradually and causes the purchasing power of currency to decline. Putting cash in investment avenues with compound interest can mitigate the negative effects of inflation.
- If you are unable to manage cash well, you won't be able to stay afloat. You need cash to fund your daily needs and to plan for long term goals. Hence, investing money in compounding interest accounts can be a good source for long-term cash management plan.
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