This compound interest calculator is a tool to help you estimate how much money you will earn on your deposit. In order to make smart financial decisions, you need to be able to foresee the final result. That’s why it’s worth knowing how to calculate compound interest. The most common real-life application of the compound interest formula is a regular savings calculation.
Interest Rate Definition
In finance, interest rate is defined as the amount charged by a lender to a borrower for the use of an asset. So, for the borrower the interest rate is the cost of the debt, while for the lender it is the rate of return.
Note that in the case where you make a deposit into a bank (e.g., put money in your savings account), you have, from a financial perspective, lent money to the bank. In such a case the interest rate reflects your profit.
The interest rate is commonly expressed as a percentage of the principal amount (outstanding loan or value of deposit). Usually, it is presented on an annual basis, which is known as the annual percentage yield (APY) or effective annual rate (EAR).
What is the compound interest definition?
Generally, compound interest is defined as interest that is earned not solely on the initial amount invested but also on any further interest. In other words, compound interest is the interest on both the initial principal and the interest which has been accumulated on this principle so far. This concept of adding a carrying charge makes a deposit or loan grow at a faster rate.
You can use the compound interest equation to find the value of an investment after a specified period of time, or to estimate the rate you have earned when buying and selling some investments. It also allows you to answer some other questions such as how long it will take to double your investment.
We will answer these questions in the examples below.
Simple vs. compound interest
You should know that simple interest is something different than the compound interest. It is calculated only on the initial sum of money. On the other hand, compound interest is the interest on the initial principal plus the interest which has been accumulated.
Most financial advisors will tell you that the compound frequency is the compounding periods in a year. But if you are not sure what compounding is, this definition will be meaningless to you… To understand this term you should know that compounding frequency is an answer to the question How often is the interest added to the principal each year? In other words, compounding frequency is the time period after which the interest will be calculated on top of the initial amount.
- annual (1/Yr) compounding has a compounding frequency of one,
- quarterly (4/Yr) compounding has a compounding frequency of four,
- monthly (12/Yr) compounding has a compounding frequency of twelve.
*Note that the greater the compounding frequency is, the greater the final balance.
Compound interest formula
The compound interest formula is an equation that lets you estimate how much you will earn with your savings account. It’s quite complex because it takes into consideration not only the annual interest rate and the number of years but also the number of times the interest is compounded per year.
The formula for annual compound interest is as follows:
FV = P (1+ r/m)^mt
- FV – the future value of the investment, in our calculator it is the final balance
- P – the initial balance (the value of the investment)
- r – the annual interest rate (in decimal)
- m – the number of times the interest is compounded per year (compounding frequency)
- t – the numbers of years the money is invested for
It is worth knowing that when the compounding period is one (
m = 1) then the interest rate (
r) is call the CAGR (compound annual growth rate).
How to calculate compound interest
Actually, you don’t need to memorize the compound interest formula from the previous section to estimate the future value of your investment. In fact, you don’t even need to know how to calculate compound interest! Thanks to our compound interest calculator you can do it in just a few seconds, whenever and wherever you want. (NB: Have you already tried the mobile version of our calculators?)
With our smart calculator, all you need to calculate the future value of your investment is to fill the appropriate fields:
- Main properties
- Initial balance – the amount of money you are going to invest or deposit.
- Interest rate – the interest rate expressed on a yearly basis.
- Term – the time frame you are going to invest money.
- Compound frequency – in this field, you should select how often the compounding applies to your balance. Usually, the interest added to the principal balance daily, weekly, monthly, quarterly, semi-annually, or yearly. But you may set it as continuous compounding as well, which is the theoretical limit for the compounding frequency. In this case, the number of periods when compounding occurs is infinite.
- Additional deposits
- How much – the amount you are planning to deposit on the account.
- How often – you can choose the frequency of the additional deposit here.
- When – you should select the timing of the transaction of the additional deposit. More specifically, you may place the money to the account at the beginning or at the end of the periods.
- Growth rate of deposit – this option allows you to set a growth rate of the additional deposit. This option can be particularly useful in the long term when your income possibly increases due, for example, to inflation and/or promotions.
That’s it! In a flash, our compound interest calculator makes all necessary computations for you and gives you the results.
The two main results are:
- the final balance, that is the total amount of money you will receive after the specified period, and
- the total interest, which is the total compounded interest payment.
In case you set the additional deposit field, we gave you the results for the compounded initial balance and compounded additional balance.
Besides, we also show you their contribution to the total interest amount, namely, interest on the initial balance and interest on the additional deposit.
Credit to : https://www.omnicalculator.com/finance/compound-interest