Compound Interest

Investments

Compound interest is interest calculated on both the principal and the accumulated interest from previous periods. Unlike simple interest which grows linearly, compound interest grows exponentially -- making it the most powerful force in personal finance for wealth building.

In detail

The key insight: interest earns interest, creating exponential rather than linear growth. The Rule of 72: divide 72 by the interest rate to find years to double your money. At 8%: 72/8 = 9 years. At 12%: 72/12 = 6 years.nnCompounding frequency matters: monthly compounding on a 7% annual rate gives an effective annual rate of 7.23%. Daily compounding gives 7.25%. The more frequent the compounding, the higher the effective yield.nnTime dimension is critical: Rs 1L at 12% for 10 years = Rs 3.1L. For 20 years = Rs 9.6L. For 30 years = Rs 29.9L. Each additional decade more than triples the corpus.

Formula

A = P x (1 + r/n)^(n x t) A = Final amount P = Principal r = Annual rate (decimal) n = Compounding frequency per year t = Time in years Effective Annual Rate = (1 + r/n)^n - 1

Real-life example

🇮🇳 India example

Rs 1 lakh at 12% compounded monthly for 30 years = Rs 35.9 lakh. The same at annual compounding = Rs 29.9 lakh. Monthly compounding creates Rs 6 lakh extra on the same principal -- just from frequency of compounding.

Frequently asked questions

What is the difference between compound and simple interest? ▼
Simple interest is always on the original principal only. Compound interest adds earned interest to principal each period. On Rs 1L at 10% for 5 years: Simple = Rs 50,000 total interest. Compound (annual) = Rs 61,051 -- 22% more.
Why should I never break a long-term investment early? ▼
Compound interest accelerates in the final years. On a 20-year investment approximately 50% of total corpus is generated in the last 5 years. Exiting in year 15 means losing half the total compounding benefit.