Famous scientist Albert Einstein once famously said that "Compound interest is the 8th wonder of the world. He who understands it earns it, and he who doesn't pays it."
The concept of compounding is compelling. If we summarize the idea in simple terms, compound interest is interest on interest. Compound interest is when the principal includes the accumulated interest from previous periods, and the following interest is calculated on this. Loans, deposits, and investments are all subject to compounding. The number of times interest is calculated in a year is known as compounding frequency. The most common compounding frequencies are daily, weekly, monthly, quarterly, half-yearly, and annually.
The compound interest calculator shows you how your money can grow by compounding interest. You can also use the compound interest calculator to see how different interest rates and loan lengths affect the amount of compounded interest you'll pay on a loan. The compound interest calculator online works on the compound interest formula. You will have to input the principal amount, the frequency of compounding, your investment tenure, and the expected rate of return. The compound interest calculator displays the results as the maturity amount at the end of investment tenure.
You can understand the calculation of compound interest with this simple example-
Say you have Rs.100000, and you are investing it for three years at 10% per annum compounded annually. For the first year, the interest will be Rs.10000 (100000*10%) on the principal Rs.100000. For the second year, the principal will be Rs.110000 (100000+ first-year interest 10000) and interest will be Rs.11000 (110000*10%). Continuing this pattern, in the third year, the principal will be Rs.121000, and interest will be Rs.12100. At maturity, you will get Rs.133100 as the maturity amount.
Since the example was for three years, it was easy to compute. But what if the tenure is longer? For this, the compound interest is calculated for any given interest and term using a formula. To calculate principal and interest, the compound interest calculator employs the compound interest formula.
Compound Interest Formula is:
A (Maturity amount) = P (1 + r/n) ^ nt
In the above formula,
A= Maturity Amount
P= Principal amount
R= Annual interest rate
N= Compounding frequency (number of times the interest is compounded) in a year
T= Number of years.
(number of times the interest is compounded) in a year, and t means the number of years.
Let's refer to an example to understand the calculation in a better way. Suppose you invest Rs.10000 for five years in an investment offering a compound interest of 10% per annum. As per the formula, the maturity amount will be-
A= 10000 (1+0.1/5) ^ 5*1 = Rs.16105.1
Out of this, the portion of accumulated interest will be
Compound interest= Maturity amount – Principal = 16105.1- 10000 = Rs.6105.1
You can use this result to determine whether a particular investment is worthwhile, as well as for planning how you will spend the money in the future.
Understanding the significance of compounding frequency in Compound interest
Compounding frequency is the number of times the interest is added to the principal amount. It makes a significant difference to the total maturity value. A higher compounding frequency translates to a higher maturity value and vice-versa.
Here’s an example to understand the impact of the compounding frequency better. Suppose you have invested Rs 1 lakh in Fixed Deposit at an interest rate of 6% for a tenure of 3 years.
Consider the interest gains are calculated every quarter. This means your compounding frequency for a year is 4. Since you have invested funds for a tenure of 3 years, the compounding frequency will be multiplied. The total compounding frequency will be 12. Think about the returns you will reap on your principal amount that’s added with compound interest these many times. Your maturity value is definitely going to be higher.
You must note that a higher compounding frequency works only in your favour when you have lent money or made an investment. A higher compounding frequency when you have opted for a loan from the bank increases your interest liability. It increases the total cost of availing the loan, proving to be heavy on your pocket.
The compounding frequency is typically decided by the bank. It can be daily, weekly, monthly, quarterly, half-yearly, and yearly. You can enquire about your bank’s compounding frequency by reaching out to their customer representative or checking their website. The bank can change the interest rate offering and compounding frequency at any given time hence you must keep a close eye on their website.
Power of compounding
Compounding is probably the simplest yet the most effective way to grow your savings. You can benefit from the power of compounding by investing in various financial instruments like – Fixed Deposits, Mutual Funds, and retirement savings schemes such as Public Provident Fund (PPF).
For example, you choose to invest Rs 1 lakh in a Fixed Deposit (FD) at a compounding interest rate of 10% for a period of 5 years. The following is a tabular representation of the returns your FD will reap with time.
Year |
Total deposit |
Interest |
Total interest |
Total balance value |
1yr |
₹1,00,000 |
₹10,001 |
₹10,001 |
₹1,10,001 |
2yr |
- |
₹11,000 |
₹21,001 |
₹1,21,001 |
3yr |
- |
₹12,101 |
₹33,101 |
₹1,33,101 |
4yr |
- |
₹13,311 |
₹46,411 |
₹1,46,411 |
5yr |
- |
₹14,641 |
₹61,052 |
₹1,61,052 |
From the above table, you can successfully conclude that your investment greatly benefits from the power of compounding.
Using the ICICI Direct Compound Interest calculator is very easy. The online tool has an extremely simple user interface, making it possible for anyone to use the calculator.
Input the following data in the calculator:
You can easily set the value of these variables using the slider. Move the slider to the left to decrease the input value and move it to the right to increase the value.
Once the calculator has processed all data it will provide accurate results within minutes. The calculator will give you an estimate of the total maturity amount. You will get a clear breakdown of the principal component and the total interest calculated. This will be accompanied by a graphical representation of the results in the form of a pie chart.
There are two methods of interest calculation – Simple Interest and Compound Interest. Both methods typically use the same set of variables however their formulas are different. The interest method adopted for your loan or investment calculation makes a significant difference. Hence, you should be aware of the difference between the two.
The following table highlights the major differences between Simple Interest and Compound Interest to make note of:
Point of difference |
Simple Interest |
Compound Interest |
Formula |
SI= (P x T x R)/ 100 |
CI = P (1 + R/100)^{t} – P |
Principal amount |
The interest is calculated on the initial principal amount. |
The interest is calculated considering the previous cycle’s maturity value. |
Total interest |
The total interest incurred or earned is lower. |
The total interest incurred or earned is comparatively higher. |
You can earn interest on the money you've saved/invested, and the interest component of your investment earns interest.
The longer your money sits in a compound interest account, the greater the benefit. Even a difference of 1% in the interest rate can increase your gains significantly in the long run.
Inflation degrades the purchasing power of money as the cost of services and goods rises over time. The effect of inflation can be mitigated by putting money into investment avenues that pay compound interest.
Compounding interest accounts can be a great source of funds for a long-term cash management strategy.
The higher the interest compounding frequency, the more money you'll make from your investment. For example, instead of compounding interest annually, the rate of return will be higher if it is compounded quarterly.
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Signup NowInterest earned on the original principal plus accumulated interest is referred to as compound interest. You're not only earning interest on your initial deposit, but you're also earning interest on your interest. Consider compound interest in the same way that the "snowball effect" occurs. A snowball begins small, but as more snow is added, it grows larger. It gets bigger at a faster rate as it grows.
When your investment earns interest, the magic of compound interest helps it to grow faster. It will calculate the newly made interest by calculating the initial capital invested and the gained interest when it earns interest again. Thus, interest will be added to the total investment amount as the size of the investment grows. This loop will continue to allow the investment to increase significantly without the need for additional capital. This cycle has the potential to expand the original investment considerably over time.
Yes, you can calculate your returns on National Savings Certificates using the compound interest calculator online.
A fixed percentage of interest is added at a fixed frequency for a set period in simple interest. Every time the interest is added, the principal remains the same, and just a fixed amount of interest is added to the principal amount. On the other hand, compound interest causes the principal to grow because the interest earned on principal earlier is also added while calculating interest.
An investor can use a compound interest calculator to figure out how much interest he or she will earn at various interest computation frequencies. On a daily, monthly, quarterly, half-yearly, or yearly basis, for example. The frequency with which interest would be compounded affects the total interest earned on the deposit.
The formula for calculating compound interest monthly is
CI = P (1 + r/n) ^ nt
Here, n stands for the compounding frequency. When calculating compound interest for 12 months, the compounding frequency is 12, that is, monthly.
You can take advantage of the power of compounding as a mutual fund investor. if you invest in a dividend reinvestment plan of a mutual fund scheme, you would receive a dividend from time to time. If the dividend is reinvested back in the mutual fund, it would allow you to purchase a larger number of units in the scheme. Now, you'll start earning a dividend not only on the original units that you had purchased, but also on the new units received through the dividend reinvestment. this has a potential to grow your investment at a faster pace.
The compound interest per month is calculated using the monthly compound interest formula. The formula is-
CI = P (1+ [r/12]) ^ 12t - P
Here P is for the principal amount, r is the decimal interest rate, and t is the time
The formula for calculating annual compound interest is as follows-
CI = P (1+ r/n) ^ nt
Where P represents the principal amount, t is the tenure, r is the rate of interest and n is the compounding frequency.
Compound interest investments are investments in assets such as Certificates of deposits, equity and debt mutual funds, bank FDs, National Pension System, Public Provident Fund, Senior Citizen's Savings Scheme, and RBI taxable bonds that benefit from compounding.
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