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After 10 years you will get ₹ 25,907
Basic Terminology Related to Compound Interest
You might have noticed that there are certain terms that are commonly repeated when taking about compound interest. Below is a list of important terms related to interest and their definition-
- Principal (P)- Principal amount refers to the initial sum of money you have invested.
- Rate of Interest (R)- The rate at which your money will grow. The higher the rate of interest the more compound interest you will accumulate on your investment.
- Compounding Frequency (N)- The number of times your investment is compounded within a year. Usually, this number is set at 1, as most interest rates are only compounded annually (once a year). However, some interest plans also offer quarterly, semi-annual, and monthly compounding options.
- Time Period (T)- Time period refers to the total number of years you are investing your money for. Time period completely depends on the terms of your plan. Some plans have a time period of just one year, while others might last for an entire decade or more.
How is Compound Interest Calculated? Formula & Calculation
The Edelweiss Life Insurance Compound Interest Calculator uses the globally standardised compound interest formula to cater to your needs and calculate the total interest. The compound interest formula has the following components -
- Principal (P)
- Rate of Interest (R)
- Compounding Frequency (N)
- Time Period (T)
A = P(1 + R/N)^(NT)
Example of How Power of Compounding/Compound Interest Works?
For example, say you invested ₹100 in a fixed deposit that pays 5% interest per annum. At the end of 1 year, the amount due to you will be ₹105. However, when the interest is calculated the next year, it will be calculated on ₹105 and not ₹100. Hence, you shall earn interest on both ₹100 (principal) and ₹5 (the interest earned), taking the value of your investment to ₹110.25. And so on, for every consecutive year till you remain invested. This is called compound interest.
What is the Meaning of ‘Power of Compounding’?
According to Einstein, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Compound interest makes a sum of money grow at a faster rate than simple interest, because in addition to earning returns on the money you invest, you also earn returns on those returns at the end of every compounding period, which could be daily, monthly, quarterly, or annually. The sooner you start investing the more advantageous it will be for you.
Here is an illustration showing you the power of compounding and how compound interest can make you create wealth.
Illustration based on -
Expected Annual Rate of Return: Calculated at 8%
Number of Years: 5
| Investment at 8% P.A. For 5 Years (in Rs) | Compound Interest (in Rs) | Simple Interest (in Rs) | Final Amount for CI (in Rs) | Final Amount for SI (in Rs) |
|---|---|---|---|---|
| 5,000 | 2,347 | 2,000 | 7,347 | 7,000 |
| 25,000 | 11,733 | 10,000 | 36,733 | 35,000 |
| 50,000 | 23,466 | 20,000 | 73,466 | 70,000 |
| 1,00,000 | 46,933 | 40,000 | 1,46,933 | 1,40,000 |
As you can see, the interest received for CI is always greater than SI for the same rate of interest, irrespective of the investment amount. As shown in the above table, for an investment of Rs 25,000; the total final amount increases to Rs 36,733 at the end of the 5th year. The difference of Rs 11,733 is the total amount of capital gains that you will be earning as interest.
On the other hand, if there was no power of compounding, then you would have earned up to Rs 10,000 as interest for the same amount (at 8% rate of interest). Therefore, the difference between the two forms of interests accrued is proof enough of the efficacy of how beneficial the power of compounding is. Starting as early as possible and being patient is the key power of compounding.
Difference between Compound Interest and Simple Interest Calculator
| Compound Interest (CI) | Simple Interest (SI) |
|---|---|
| Refers to the interest on both investment amount and accumulated interest | Refers to the interest on the total investment amount. |
| Offers comparatively higher returns | Offers lower returns |
| Principal amount continues to change as additional amount keeps accumulating |
Principal remains same throughout |
| Principal and interest growth increases rapidly | Principal and interest growth remains constant |
| Interest applies on the principal amount as well as on the accrued interest | Interest applies on only the principal amount |
| Formula = P * (1 + R/N) ^ NK Where, P = principal, R = rate of interest, N =no. of years, K = Times of compounding | Formula = P*R*N Where, P = principal, R = rate of interest, N = no. of years |
| Compound interest calculator is useful in terms of investments. It allows your fund to grow quickly. | Simple interest calculator is useful while buying an asset on debt, e.g., a car loan. |
How Does the Compound Interest Calculator Work?
As shown above, the compound interest calculator simply uses the formula A = P(1 + r/n)^(nt) to calculate the amount you will receive in the future with compound interest. The benefit of using a compound interest calculator is that it is instantaneous, so you can make multiple calculations using different principal amounts within just a minute.
How to Use Compound Interest Calculator?
- Enter the principal amount you would like to start investing with.
- Select the compounding frequency and the period of time you would like to stay invested for.
- Enter the rate of return you are expecting, and our compound interest calculator will display the results in the blink of an eye.
Benefits of Using Compound Interest Calculator
Customised Result Based
Easy to use, within a few clicks you get a customised result based on your needs
Source Of Information
A reliable source of information
Plan Your Investments
Helps you plan your investments
Graph Gives Clarity
The illustrative and user-friendly graph gives clarity
Benefits of Using Compound Interest Calculator
Customised Result Based
Easy to use, within a few clicks you get a customised result based on your needs
Source Of Information
A reliable source of information
Plan Your Investments
Helps you plan your investments
Graph Gives Clarity
The illustrative and user-friendly graph gives clarity
Which Investments Use Compound Interest?
When it comes to investing, it's always a good idea to go with an option that allows you to benefit from compound interest. This is the most effective method for maximising your profits and getting the highest value out of your money.
There is a variety of investing options available today, which allow you to benefit from plans that compound interest on a regular basis. Banks provide compound interest at the most basic level. Every six months, the interest you earn is added to your savings, and you can earn interest on the new amount for the next six months. However, this is insufficient to assist you in achieving your financial objectives.
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What does Compounding mean?
Compounding is a process where your earning from an investment is reinvested to further generate even more earnings. Compound interest uses the power of compounding by accruing interest upon the interest you have already acquired.
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What is the benefit of Compound Interest?
Compound interest is one of the best ways to grow your wealth quickly. The easiest way to define compound interest is that it is interest that you get on your preexisting interest. The interest you earn on your principal is added to the original amount, which then becomes the principal for the next cycle. Compound interest can turn a small investment into a significant profit over a lengthy period of time. Here, the growth rate is computed basis the savings you accumulate over a period in addition to the original investment amount. Compound interest allows your money to grow exponentially as your initial investment and the earnings you've generated grow in tandem.
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How does Compound Interest Power work?
Compound interest works by maximizing your savings exponentially. It adds the returns received, back to the investment amount and reinvests the total returns, thus resulting in a magnified returns earning process.
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What is the frequency of Compound Interest Calculation?
The number of times interest is compounded can vary. However, below are the standard practices:
- Annual compounding
- Half-yearly compounding
- Quarterly compounding
- Daily compounding
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What is the formula for compound interest?
The formula for compound interest that is a globally standardized method is A = P(1 + r/n)^(nt), where:
- Principal (P)
- Rate of Interest (R)
- Compounding Frequency (N)
- Time Period (T)
For example, an investment of ₹1,00,000 at a 12% rate of return for 5 years compounded annually will be ₹1,76,234. From the graph below we can see how an investment of ₹1,00,000 has grown in 5 years.
| Year | Investment (₹) | Interest (₹) | At Maturity (₹) |
|---|---|---|---|
| 1 | ₹1,00,000 | ₹12,000 | ₹112,000 |
| 2 | ₹1,12,000 | ₹13,440 | ₹125,440 |
| 3 | ₹1,25,440 | ₹15,052.8 | ₹1,40,492.8 |
| 4 | ₹1,40,492.8 | ₹16,859.14 | ₹1,57,351.9 |
| 5 | ₹1,57,351.9 | ₹18,882.2 | ₹1,76,234.2 |
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Which is better – annual compounding or daily compounding or monthly compounding?
The difference between annual, daily, or monthly compounding is not much. However, it is better to opt for daily compounding, as its interest amount is slightly higher. After all, shorter the compounding frequency, higher the interest!
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What does compounding monthly and yearly mean?
When you are choosing an investment that offers compound interest, you can choose plans where the interest is accrued daily, monthly, six-monthly, or annually. For example - Let’s say Mr A has made an investment of ₹10,000 for just 3 years at a rate of 7%. If annual compounding is applied, he’ll gain ₹12,250 at the end of 3 years. If the compounding was done on a half-yearly basis, he would end up with ₹12,314 and if it was done monthly, he’d end up with ₹12,293.
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What is the difference between Simple Interest and Compound Interest?
Compound interest gives you additional earnings by reinvesting your interest into the principal amount. This causes the principal amount to keep increasing with each passing year. On the other hand, simple interest just multiplies your total principal amount with the total number of years and the rate of interest.
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Is compound interest better than simple interest?
Yes, if growing your wealth is your primary goal, then compound interest is much better than simple interest. The principal amount in compound interest keeps increasing as more interest value is added to the original sum, meaning that you are getting interest on the interest already accumulated. Simple interest is just a direct calculation where your principal amount remains the same throughout your entire investment term. To put it simply, the interest amount in CI is significantly higher than the interest amount in SI.
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How can you easily calculate compound interest?
You can calculate compound interest by yourself using the formula:
CI= P x (1 + R/N)NK
Where P is the principal amount, R is the rate of interest, N is the number of years, and K is the number of times the principal is compounded in a year. Or, you can simply use the compound interest calculator to get the value of your investment growth in a single click.
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Is there a separate method for computing simple interest as well?
Calculating simple interest is much easier. Just use the formula given below to calculate simple interest by yourself:
SI= P x R x T
Where P is the principal amount, R is the rate of interest, and T is the number of years.
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