Compound Interest

What Is C.I and How Does It Work?

The interest you get on a deposit is called compound interest (CI) or compounding interest. It is computed using the starting principal as well as the interest accumulated for a specific period. The compound interest formula basically works on the concept of compounding, which means the rate at which the sum increases is quicker than the normal form of interest. It is because with a simple interest we calculate interest only on the main whole amount

The compound interest formula increases at a rate, which is usually determined by compounding frequency. The C.I rate increases when the compounding periods increase.

Thus, during the same time period, the C.I amount of INR 500 at a 5% semi-annual rate will be more than the INR 500 at a 10% annual rate. Thus, the interest-on-interest rule can yield more positive returns on the original principal amount.

Interest can be accumulated daily, weekly, monthly, or annual basis. Standard compounding frequency plans are commonly used with financial products.

How Does It Grow?

Compounding’s most important feature is that it pays interest on previously earned interest as well as the basic capital. Compounding is all about creating a broad foundation that keeps adding to your prior earnings.

If you invest Rs 1 lakh and compound it at 10% every year for the next fifteen years, you’ll have a foundation of about Rs 4,10,725. This is how compounding generates a never-ending cycle of earnings. Keep in mind as an investor the most important aspect of compounding would be that the investment’s earnings should be reinvested. It is not permissible to withdraw one’s returns at any time. This profit withdrawal will prevent the investment’s base from growing to a larger amount.

Compound Interest Calculator

Compound interest calculator is derived by taking the principal amount and raising it exponentially by one and given yearly interest rate by the frequency of periods (denoted by n) minus one. Interest can be compounded on a variety of schedules, ranging from constant to daily to annual. 

The number of compounding periods makes a major influence when calculating compound interest. Compound interest calculator is determined using the following equation: A (Maturity amount) = P (1 + r/n) nt. P stands for the principal amount, r for the yearly interest rate, n for the compounding frequency (number of times that interest is compounded) in a year, and t for the number of years in the calculation.

Compound Interest Formula Example

The compound Interest Formula Example is as follows: 

Compound interest = Total value of amount compounded on future basis minus the present balue

= [P (1 + r)t] – P

= P [(1 + r)t – 1]

Where:

P = principal

r =  the annual interest rate 

t = amount of the compounding periods

Let’s understand this through a compound Interest question. 

Karma International Ltd makes Rs.10,000 initial investment for a two-year period. If the investment produces a 2% compounded quarterly return, calculate the value of the investment after two years.

The following compound interest formula will be used in this compound interest question to compute the value of the investment after two years:

A = P (1 + r / m) mt

In the present case,

A (Future Value of the investment) is to be calculated

P (Initial value of investment) = Rs. 10,000

r (rate of return

) = 2% compounded quarterly

m (number of the times compounded quarterly) = 4 (times a year)

t (number of years for which investment is done) = 2 years

Now,the calculation of future value (A) can be calculated as follows: 

A =Rs 10,000 (1 + 0.02 / 4) 4*2

A =Rs10,000 (1 + 0.02 / 4) 8

A = Rs10,000 (1.005) 8

A =Rs 10,000 * 1.0407

A = Rs10,407.07

As a result, if the return is 2% compounded quarterly, the initial investment of Rs. 10,000 will be worth Rs. 10,407.07 after two years.

Conclusion

When interest is applied to the invested amount or borrowed, compound interest occurs, and the interest rate is applied to the new (bigger) principal. It’s just interest on interest, which leads to an exponential increase over time. When your investments and savings grow over time, compounding can work in your favor—or against you if you’re paying off debt.