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The compound interest formula calculates the future value of an investment including interest earned on previously accumulated interest.
A = P(1 + r/n)^(nt)
Where:
A = Final Amount (Principal + Interest)
P = Initial Principal Amount
r = Annual Interest Rate (as a decimal, e.g., 8% = 0.08)
n = Number of times interest compounds per year
• Yearly: n = 1
• Quarterly: n = 4
• Monthly: n = 12
• Daily: n = 365
t = Time in years
With Monthly Contributions:
A = P(1 + r/n)^(nt) + PMT × [((1 + r/n)^(nt) - 1) / (r/n)]
PMT = Monthly contribution amount
Example:
Principal: $10,000
Interest Rate: 8% per year
Compounding: Monthly (n = 12)
Time: 10 years
A = 10,000(1 + 0.08/12)^(12×10) = $22,196.40
Interest Earned: $12,196.40
Compound interest is interest calculated on the initial principal and accumulated interest from previous periods. It's 'interest on interest' - as your investment grows, you earn interest on a larger amount, leading to exponential growth over time.
Compound interest is calculated using the formula: A = P(1 + r/n)^(nt), where A is the final amount, P is the principal, r is the annual interest rate, n is the number of times interest compounds per year, and t is the time in years.
Simple interest is calculated only on the principal amount, while compound interest is calculated on both principal and accumulated interest. Compound interest grows exponentially and yields significantly higher returns over time compared to simple interest.
More frequent compounding leads to higher returns. Daily compounding yields the most, followed by monthly, quarterly, and yearly. However, the difference becomes marginal for longer periods. Most banks offer monthly or quarterly compounding.
Monthly contributions significantly boost returns by continuously adding to the principal. Each contribution then earns compound interest, creating a snowball effect. This strategy, called dollar-cost averaging, is powerful for long-term wealth building.
Rates vary by investment type: High-yield savings accounts: 4-5%, Fixed deposits: 6-8%, Stock market (historical average): 10-12%, Real estate: 8-10%. Higher rates come with higher risk. Consider your risk tolerance and investment goals.
The longer you invest, the greater the compounding effect. The 'Rule of 72' states your money doubles in 72/interest rate years. At 8% interest, money doubles in 9 years. For maximum benefit, invest for at least 5-10 years.
Yes, compound interest on debt (like credit cards) works against you. Credit card debt compounds monthly at 18-36% APR, causing balances to grow rapidly. Always pay more than minimum payments to avoid compounding debt trap.