Compound Interest Calculator
Understanding Compound Interest
What is Compound Interest?
Compound interest is the interest calculated on the initial principal and also on the accumulated interest from previous periods. Often called "interest on interest," it's one of the most powerful concepts in finance and investing. Albert Einstein allegedly called it "the eighth wonder of the world."
How Compound Interest Works
Unlike simple interest, which is calculated only on the principal amount, compound interest is calculated on:
- The initial principal amount
- All previously earned interest
- The frequency of compounding affects the total return
- Time is the most critical factor for maximizing compound growth
The Compound Interest Formula
The compound interest formula is:
A = P(1 + r/n)^(nt)
Where:
A = Final amount
P = Principal (initial investment)
r = Annual interest rate (as decimal)
n = Number of times interest compounds per year
t = Time in years
Compound Interest = A - P
The more frequently interest compounds, the greater the final amount will be.
Compounding Frequencies Explained
Annual Compounding
Interest is calculated and added once per year. This is the simplest form of compounding.
Monthly Compounding
Interest is calculated and added 12 times per year, resulting in higher returns than annual compounding.
Daily Compounding
Interest is calculated and added 365 times per year, maximizing the compound effect.
Continuous Compounding
The theoretical limit where interest is compounded infinitely often, using the formula A = Pe^(rt).
The Power of Time in Compound Interest
Time is the most crucial factor in compound interest. The longer your money compounds, the more dramatic the growth becomes:
- Starting early gives you a significant advantage
- Even small amounts can grow substantially over time
- The growth accelerates in later years (exponential growth)
- Consistency in investing amplifies the compound effect
Compound Interest vs Simple Interest
Simple Interest
Formula: I = P × r × t
- Calculated only on principal
- Linear growth
- Lower returns over time
Compound Interest
Formula: A = P(1 + r/n)^(nt)
- Calculated on principal + interest
- Exponential growth
- Significantly higher returns
Practical Applications
- Savings accounts and certificates of deposit
- Investment portfolios and retirement accounts
- Bond investments and treasury securities
- Real estate appreciation over time
- Business reinvestment and growth
Tips for Maximizing Compound Interest
- Start investing as early as possible
- Choose investments with higher compounding frequencies
- Reinvest all dividends and interest payments
- Make regular contributions to amplify growth
- Be patient and avoid withdrawing early
- Consider tax-advantaged accounts for better compound growth