What is Compound Interest?
Compound Interest is often called the "eighth wonder of the world". Unlike Simple Interest, where you earn interest only on the principal, Compound Interest allows you to earn interest on interest.
This compounding effect causes your wealth to grow exponentially over time, making it the most powerful concept in finance and investing.
The Formula Explained
The mathematical formula used to calculate the final amount (A) is:
- P: Principal Amount (Initial Investment)
- r: Annual Interest Rate (decimal)
- n: Compounding frequency per year
- t: Time period in years
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Compounding Frequency Explained
The frequency at which interest is added to your account significantly impacts returns.
| Frequency | n Value | Common Examples |
|---|---|---|
| Yearly | 1 | PPF, EPF (credited yearly) |
| Half-Yearly | 2 | Corporate Bonds |
| Quarterly | 4 | Bank Fixed Deposits |
| Monthly | 12 | Savings Accounts |
The Power of Compounding (Example)
Suppose you invest ₹1,00,000 for 10 years at 10%:
- Simple Interest: Final amount = ₹2,00,000
- Compound Interest: Final amount = ₹2,59,000
That extra ₹59,000 is purely due to compounding — money earning money.