How Compound Interest Works

Compound interest is the interest calculated on both the initial principal and the accumulated interest from previous periods. It allows your money to grow faster compared to simple interest, where interest is calculated only on the principal.

The Basic Formula

The formula for compound interest is:

$$A = P \left(1 + \frac{r}{n} \right)^{nt}$$

Where:

• A = final amount (including interest)

• P = principal (initial investment)

• r = annual interest rate (as a decimal)

• n = number of times interest is compounded per year

• t = time in years

Example

Let’s say you invest ₹10,000 at an annual interest rate of 8%, compounded yearly, for 5 years.

$$A = 10,000 \left(1 + \frac{0.08}{1} \right)^{1 \times 5} = 10,000 \times (1.08)^5 ≈ ₹14,693$$

So, in 5 years, you earn ₹4,693 in interest.

Power of Compounding

The more frequently interest is compounded, the more you earn. For example:

• Compounded annually – once a year

• Compounded quarterly – 4 times a year

• Compounded monthly – 12 times a year

• Compounded daily – 365 times a year

The more frequent the compounding, the more interest you'll earn.

Why It Matters

• Great for long-term savings (like retirement funds)

• Helps build wealth over time

• Small amounts invested early can grow significantly due to compounding

Pro Tip

Start early, reinvest earnings, and be consistent — that’s the real magic of compound interest.

Want a calculator or a visual chart for compound interest over time?

July 02, 2025 Tags : Finance & Money

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