Compound interest means you earn interest on your interest. In the first year it looks the same as simple interest. Over many years the difference becomes large. This guide explains the idea with numbers you can check on the compound interest calculator.
Simple interest vs compound interest
With simple interest, you earn interest only on the original amount. With compound interest, each period’s interest is added to the balance, and the next period’s interest is worked out on the larger balance.
The compound formula is:
Final amount = P x (1 + r / n) ^ (n x t)
- P is the starting amount.
- r is the yearly rate as a decimal.
- n is how many times a year interest is added.
- t is the number of years.
A worked example
Start with Rs 1,00,000 at 8% a year for 10 years.
Simple interest: 1,00,000 x 8% = Rs 8,000 a year. Over 10 years that is Rs 80,000, so the final amount is Rs 1,80,000.
Compound interest, added once a year: 1,00,000 x 1.08 ^ 10 = about Rs 2,15,892. The interest earned is about Rs 1,15,892.
The compound version earns about Rs 35,892 more, with the same rate and the same time.
Time matters most
Keep the same Rs 1,00,000 at 8% compounded yearly for 20 years and it grows to about Rs 4,66,096. Doubling the time more than doubles the result. That is why starting early is often described as the biggest factor in long-term saving.
Compounding frequency
Interest can be added yearly, quarterly, monthly or daily. More frequent compounding gives a slightly higher result. At 8% for 10 years on Rs 1,00,000, monthly compounding gives about Rs 2,21,964, compared with Rs 2,15,892 for yearly. The difference is real but small next to the effect of the rate and the years.
Regular contributions
The calculator also lets you add a monthly contribution. Each contribution starts compounding from the month it is made, which is why steady saving can build a large amount over time.
Things to remember
- Results depend on the rate you assume. A real investment may earn more or less, and some products carry risk.
- Charges, tax and inflation are not included, so the real value of the final amount can be lower.
- This is an educational estimate, not financial advice.
Steps
- Open the compound interest calculator.
- Enter the starting amount, the monthly contribution (use 0 if none), the yearly rate and the number of years.
- Choose how often interest is added.
- Read the final balance and compare it with the amount you put in.
- Change the years or the rate to see how sensitive the result is.