Compound Interest Breakdown
What is Compound Interest?
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Unlike simple interest — which only applies to your original amount — compounding means you earn interest on your interest. This causes your money to grow exponentially rather than linearly, especially over long time horizons. It is the foundation of long-term wealth building.
Compound Interest Formula
The standard formula is: A = P × (1 + r/n)^(n×t)
Where: P = Principal amount, r = Annual interest rate (as a decimal), n = Number of compounding periods per year, t = Time in years, A = Final amount after interest. Compound Interest = A − P.
Example: ₹1 Lakh at 8% for 5 Years
To see the real power of compounding frequency, compare ₹1,00,000 invested at 8% annual rate for 5 years across different frequencies. Annual compounding returns ₹1,46,933. Quarterly compounding returns ₹1,48,451. Monthly compounding returns ₹1,48,886. The difference of nearly ₹2,000 may seem small here, but on ₹10 lakh over 10 years, the gap is ₹60,000+.
What is Effective Annual Rate (EAR)?
The Effective Annual Rate (EAR) is the actual annual return you earn after accounting for within-year compounding. It is calculated as: EAR = (1 + r/n)^n − 1. For example, 8% compounded quarterly has an EAR of 8.24%. This is the number you should use when comparing investment products with different compounding frequencies — not the nominal rate.
Compound Interest in Indian Investments
In India, Fixed Deposits (FDs) at most banks — including SBI, HDFC, and ICICI — compound quarterly. Savings account interest is typically calculated daily but credited monthly or quarterly. PPF compounds annually on March 31. Mutual fund SIPs do not have a fixed compounding frequency — growth depends on NAV appreciation, which is effectively continuous. For long-term goals like retirement or education, the compounding effect over 15–30 years is the single most powerful factor in final corpus size.
Compound Interest vs Simple Interest
For short time periods (1–2 years), the difference between compound and simple interest is small. But as time increases, the gap becomes substantial. On ₹5,00,000 at 9% for 15 years: simple interest gives ₹6,75,000 in interest; compound interest (quarterly) gives approximately ₹12,93,000 in interest — nearly double. This is why starting early matters far more than investing a larger amount later.
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Frequently Asked Questions
The formula is A = P × (1 + r/n)^(n×t). A is the final amount, P is the principal, r is the annual rate as a decimal, n is the compounding frequency per year, and t is time in years. Compound Interest = A − P.
The more often interest compounds, the more you earn. For ₹1,00,000 at 8% for 5 years: annual compounding gives ₹1,46,933; quarterly gives ₹1,48,451; monthly gives ₹1,48,886. The gap grows with larger amounts and longer durations.
Simple interest is calculated only on the original principal. Compound interest is calculated on the principal plus all previously earned interest. Over time, compound interest grows much faster — the longer the duration, the greater the difference.
Most Indian bank Fixed Deposits compound interest quarterly (4 times per year). Some banks offer monthly compounding. Always check your bank's specific FD terms. Select "Quarterly" in the calculator above for most FD calculations.
EAR is the true annual return after factoring in within-year compounding. Formula: EAR = (1 + r/n)^n − 1. For example, 8% compounded quarterly gives an EAR of 8.24%. Use EAR when comparing products with different compounding frequencies.