What is Compound Interest?
Unlike simple interest, which adds a fixed return, compound interest builds on itself. Every time interest is added to your savings, that total becomes the new base. So next time, your money earns interest not only on the original amount, but also on the gains already made.
This compounding effect causes investments to grow faster over time, much like a snowball gaining size as it rolls downhill.
Unlike simple interest, which is calculated only on the principal, compound interest is calculated on both the principal and the accumulated interest. This is what makes it so powerful for long-term growth.
When you then start introducing regular, consistent investing over a sustained period of time, the effects of compound interest are amplified, giving you a highly effective growth strategy for accelerating the long-term value of your savings or investments.
Why Choose Compound Interest?
Compound interest accelerates wealth building far beyond simple interest, making it ideal for savings, investments, and retirement planning due to its exponential effect. Starting early maximizes gains, as time amplifies the "interest on interest" mechanism, often called the "eighth wonder of the world." Borrowers face higher costs with compounding, so savers and investors benefit most by selecting accounts or assets with frequent compounding.
How to Calculate Compound Interest?
Groww uses a globally standardized method to determine the total compound interest accrued. The formula is –
A = P (1 + r/n) ^ nt
The variables in the formula are the following.
P : Principal Amount A : Compound interest R/r : Rate of interest N/n : Number of times interest compounds in a year T/t : Number of years
For example, if you invest Rs. 50,000 with an annual interest rate of 10% for 5 years, the returns for the first year will be 50,000 x 10/100 or Rs. 5,000.
For the second year, the interest will be calculated on Rs. 50,000 + Rs. 5000 or Rs. 55,000. The interest will be Rs. 5550.
For the third year, the amount will stand at Rs 6055 and so on.
Obviously, it is difficult to calculate these amounts manually. That is why you need a compound interest calculator in India to make the task easier.
Types of Compound Interest
Compound interest can be categorised into different types based on its calculation frequency and structure. The most common types include daily, monthly, quarterly, semi-annual, and annual compounding, each affecting the final interest accrued. Additionally, continuous compounding provides the highest returns by applying interest constantly. Understanding these types helps in choosing the best financial strategy.
- Monthly Compounding: Interest is compounded monthly and commonly used in savings accounts.
- Quarterly Compounding: Interest is applied every three months, as seen in fixed deposits.
- Semi-Annual Compounding: Interest is added twice a year, which benefits bonds.
- Annual Compounding: Interest is compounded once a year, typical for long-term investments.
Harnessing compound interest through consistent saving and investing unlocks substantial long-term wealth, far outpacing simple interest. Start early, choose high-yield options with frequent compounding, and use calculators to plan effectively.
Note: These calculations are for educational purposes only and do not constitute financial advice.