What is Compound Interest?
Compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. It's essentially "interest on interest," and it's one of the most powerful concepts in finance.
The formula for compound interest is:
A = P(1 + r/n)^(nt)
Where:
- A = Final amount
- P = Principal (initial investment)
- r = Annual interest rate (decimal)
- n = Number of times interest is compounded per year
- t = Time (in years)
The Power of Compound Interest
Albert Einstein supposedly called compound interest "the eighth wonder of the world," saying, "He who understands it, earns it; he who doesn't, pays it."
The power of compound interest lies in its exponential growth over time. The longer you let your money compound, the faster it grows. This is why starting to save early is so important for long-term financial goals like retirement.
Compound Interest vs. Simple Interest
Unlike compound interest, simple interest is calculated only on the principal amount. The formula for simple interest is:
A = P(1 + rt)
Over time, the difference between compound interest and simple interest can be substantial. For example, $10,000 invested at 5% for 30 years would grow to:
- $25,000 with simple interest
- $43,219 with compound interest (annually)
Factors That Affect Compound Interest
Interest Rate
Higher interest rates lead to faster growth. For example, money growing at 8% will double in about 9 years, while money growing at 4% takes about 18 years to double.
Compounding Frequency
The more frequently interest is compounded, the more your money will grow. Common compounding frequencies include annually, semi-annually, quarterly, monthly, and daily.
Time Period
Time is perhaps the most important factor in compound interest. The longer your money has to grow, the more dramatic the effects of compounding become.
Additional Contributions
Regular contributions to your investment can significantly accelerate its growth. Even small regular deposits can make a big difference over time.
The Rule of 72
The Rule of 72 is a simple way to determine how long it will take for your investment to double given a fixed annual rate of interest. You divide 72 by the annual rate of return:
Years to double = 72 / Interest Rate
For example, if you have an investment that earns 8% per year, it will take approximately 72 รท 8 = 9 years for your investment to double.
Using Our Compound Interest Calculator
Our calculator helps you see how your investments can grow over time with compound interest. By adjusting variables like initial investment, additional contributions, interest rate, and time period, you can explore different scenarios and make informed decisions about your savings and investment strategies.
Remember that the results provided by this calculator are estimates based on the information you input. Actual results may vary due to factors such as changing interest rates, taxes, and fees.