How Compound Interest Works?
Albert Einstein famously described compound interest to be the 8th wonder of the world. The concept of compound interest is simple – accumulated interest is added back to the principal and you will earn interest on the interest. This might not sound much but it really is and that is probably the reason for Einstein’s famous quote.
Another famous quote related to compound interest comes from Warren Buffett and is as follows: “Time is your friend; impulse is your enemy. Take advantage of compound interest and don’t be captivated by the siren song of the market.” Play with the calculator and see the benefits of time and interest on your money to see yourself!
How to Use Our Compound Interest Calculator?
Luckily using our calculator does not require Einstein’s or Buffet’s brain power and is very simple. Start by submitting
- your starting amount,
- time period,
- interest rate and
- compounding frequency or compounding period (daily, monthly or yearly)
The Math Behind Compound Interest
Should you want to examine the compounding effect and make your own calculations in Excel compound interest calculator, the formula to calculate compound interest is
A = P * (1 + n*r)^ n*t
where:
- A is the final amount or balance
- P is the original principal amount or initial deposit
- r is the annual interest rate
- n is the compounding frequency
- t is the total time interest is applied
Please note that our calculator displays nominal values and is free of inflation.
Common Use Cases for Compound the Calculator
The compound interest calculator usage is not limited to assessing investment growth on a cash savings account or Cash ISA. It can also be used for:
- Setting saving goals: Estimate how much you need to save in order to achieve your goal in a given time period.
- Investment planning: Project long-term returns on investments like ISAs, bonds, mutual funds, ETFs or adjust your overall investment portfolio strategy.
- Comparing interest rates: See how different rates and compounding frequencies affect total returns. Examine if it is worth changing to another high-yield savings account or banking provider.
- Retirement forecasting: Calculate future nest egg value with or without monthly contributions.
- Loan cost estimation: Understand how much interest accumulates over time on compound-based loans.
- Education funds: Plan how much to set aside now to reach a target amount for school fees.
We find it especially useful for testing “what-if” scenarios and making smart, data-informed financial decisions.
For example, what if my equity investments grow faster and annual return rate is 9% instead of 6%? How much more will I have in 10 years if I save £200 monthly instead of £100?
FAQ
How long it will it take £10,000 to double at 8% compound interest?
Approximately 8 years and 9 months. The exact time depends on compounding frequency. If compounded daily, you will reach £20,000 one month earlier in 8 years in 8 months.
Where can I get interest compounded daily?
First check if your bank and account type already has daily, monthly or annual compounding. In the UK daily compounding is the most common compounding frequency on Easy-Access Savings accounts and Cash ISAs. However, regular savings accounts might use monthly compounding.
What is the rule of 72?
The Rule of 72 is a quick and easy mental math formula used to estimate how long it will take for an investment to double, based on a fixed annual interest rate. The formula is Years to Double = 72 / Annual Interest Rate.
What is the Effective Annual Interest Rate (EAR)?
The Effective Annual Interest Rate (EAR), also known as the annual equivalent rate (AER) or effective annual yield, is the actual interest rate an investor or borrower earns or pays in a year after accounting for the effects of compounding. It provides a more accurate reflection of the true cost or return of a financial product than the nominal rate, especially when interest is compounded more than once per year. Main point is that higher the compounding frequency the higher the EAR.
Is daily compounding better than monthly?
Yes. Higher the compounding frequency, the more interest you earn. The difference is often small, but daily compounding will still put a little more money in your pocket.
What is a compound interest calculator?
A compound interest calculator estimates the future value of an investment or loan by factoring in interest that compounds over time. It requires inputs like principal, rate, time, and compounding frequency. Unlike simple interest, it includes interest on previous interest, making it useful for financial planning and long-term growth predictions.
