How to calculate compound interest?

Compound Interest Calculator

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COMPOUND INTEREST CALCULATOR

It is often said that compound interest is the eighth wonder of finance. The compound interest calculator is a quick method of estimating the future compounded value of an investment over a period of time. The compound interest calculator is flexible enough to be used for multiple types of frequency like monthly, quarterly and half yearly compounding. You can use the compound interest calculator online available on the website. For a more Indianized version of the calculator, you can ideally look for compound interest calculator in rupees.


One of the major purposes of the compound interest calculator is to tell you what your capital today is going to be worth tomorrow. The compound interest calculator is especially useful when you are looking to create wealth over the long term. Let us understand the concept of compound interest and the idea of compound interest calculator online in greater detail.


WHAT IS COMPOUND INTEREST?

Compounding interest needs to be understood in contrast to simple interest. When you use compound interest, your wealth increases exponentially because you earn interest on your total investments and the interest on interest. The cumulative impact can be easily assessed with the help of a compound interest calculator. Most of the investment and financial planning and advisory business largely thrives on the concept of compounding wealth, which is best captured by compound interest or compounded annual returns or CAR. One needs a reliable compound interest calculator to ensure you are on track. For example, with the compound interest calculator you can easily estimate if you will earn enough on your investments at the end of a particular period to cover your liabilities.



HOW TO USE COMPOUND INTEREST CALCULATOR?

Let us now look at how to use the compound interest calculator. You start by giving some key inputs and feeding them into the compound interest calculator. Let us first understand the formula which can be summarized as under.


A = P (1 + R/N) ^ NT


Let us quickly understand what these various parameters imply.


P is the original investment or the principal Amount


A is the final amount or wealth including compound interest


R is the rate of interest or return payable


N is the number of times interest compounds, so for quarterly, N is 4


T is the total number of years tenure of the investment


Once you feed all these parameters, you can get the eventual compounded amount on your fingertips.


Understanding working of a compound interest calculator


The compound interest concept is a progressive growth concept. For example, if you invest Rs.100,000 with an annual interest yield of 10% for 5 years, the returns for the first year will be 100,000 x 10/100 or Rs.10,000.


However, for the second year, the interest will be calculated on Rs.100,000 + Rs.10,000 or Rs.110,000. The interest will be Rs.11,000. For the third year, the amount of interest will be Rs.12,100.


What we have considered is a very simple and fundamental example. In reality these calculations can get quite complex and cannot be done manually. This requires the use of compound interest calculator for the purpose. These calculators help you to simulate your experiences into a clear cut model and estimate how much you need to invest and how much risk you need to take for a certain wealth target.


HOW CAN A COMPOUND INTEREST CALCULATOR HELP YOU?

Here is how the compound interest calculator can be of help to investors. The nature of compound interest makes it very relevant for businesses. When you use a compound interest calculator online, here are the benefits.

  • The compound interest calculator enables you determine an accurate figure and percentage of returns over a certain time frame.
  • The compound interest calculator helps you to identify the quantum of investment you need over a time frame. You can simulate the final corpus based on different return and compounding assumptions.
  • The compound interest calculator is quite simple as it enables you to get a reliable output based on some very simple parameters. You just need to input basic parameters like principal, rate of interest, period, frequency of compounding etc.
  • The compound interest calculator enables you to separate the basic interest and the compounded portion out of the total returns. At any point, the compound interest calculator helps you to determine the impact of interest on principal and the interest on interest.

One of the most important and well accepted measures in the world of finance is compound interest. It is very useful for long term wealth creation since it assumes that the intermittent cash flows are reinvested in the investment. This enables to build value over a longer time frame. Normally, compounding has a huge impact on the eventual wealth and that can be simulated quite effectively using the compound interest calculator.


FREQUENTLY ASKED QUESTIONS

What are the benefits of compound Interest?


Compound interest assumes that the interest or returns earned on an asset are also reinvested back into the same instrument. Compound interest is a more realistic measure of value since it also factors in the interest on interest component, unlike the simple interest which only looks at the interest on principle. For long term wealth creation, the power of compounding is an important concept.


What Is Daily, Monthly & Early Compounding?


Compounding is normally done on an annual basis. For example, if Rs.1000 invested at 12%, then for the second year, the principal amount is Rs.1,254 for the third year and Rs.1,405 for the fourth year. This is how it goes on. This is annual compounding. But quite often, to make offers attractive, such returns are also compounded at shorter intervals like quarterly compounding, monthly compounding and even daily compounding. As you increase the frequency of compounding, the eventual compounded sum increases.


What Are Compound Interest Investments?


Compound interest investments are basically investments that create wealth over the long term through the power of compounding. The logic is that when the interest on interest is also considered, then over time the impact of compounding on investments makes money work much harder on your behalf.


What is the formula for Compound interest?


The formula for compound interest can be summarized as under.


A = P (1 + R/N) ^ NT


Let us quickly understand what these various parameters imply.


P is the original investment or the principal Amount


A is the final amount or wealth including compound interest


R is the rate of interest or return payable


N is the number of times interest compounds, so for quarterly, N is 4


T is the total number of years tenure of the investment


What is the difference between simple interest and compound interest?


Simple interest does not consider the impact of interest on interest while compound interest also considers the interest on interest. For example, if you are invested in a bond worth Rs.1000 paying interest of 10%, then the simple interest each year will only be Rs.100.


However, in the case of compound interest, the interest amount will get compounded and every subsequent year the interest will be calculated on the compounded amount. In the above case, the amount will be Rs.1,100, 1210, 1331, 1464, 1611 etc over the next five years. In the simple interest formula, at the end of five years, the total amount received is Rs.500 while in compound interest the amount received is Rs.611, this difference of Rs.111 is the effect of compound interest.


How important is the frequency of compounding?


The more frequently you compound, the eventual wealth created is much higher. For example, the wealth created by half yearly compounding is more than annual compounding and on quarterly compounding is more than half yearly compounding. This goes on progressively. With the same returns, more frequent the compounding, the higher the eventual compounded amount.