It's no surprise that compound interest may be a tremendous help when it comes to your finances. Your financial planning is built on the principle of compounding to help you build wealth over time. While investing, you can use a compounding calculator available online to determine the expected amount based on your investment and tenure. So, what precisely is compound interest, and how do you compute it? Keep reading because we'll address all of your questions in this article.

What is Compounding?

Compounding occurs when you gain interest in your investment over time, increasing your earnings. With the power of compounding, investors buying top mutual funds in India get exponential returns on their investment. Likewise, long-term investors who invest in top mutual funds in India see their money grow dramatically owing to the power of compounding.

What is Compound Interest and How to Calculate It?

In layman's terms, compound interest occurs when interest is applied to the initial sum of an investment after a specified period. It is so named since the accumulated interest is joined to the principal sum. Then, the interest for the following period is then computed on the new total sum, which is the addition of the initial and accumulated interest amounts from the previous period. This practice is performed throughout the life of the investment. So, in essence, interest is determined by compounding the principal amount and the previously generated interest. Investors taking the SIP route can also use the compounding calculator to calculate the expected returns at the end of the maturity term.

Let us understand how to calculate the compound interest and how it affects your investments.

Assume that X makes a Rs 50,000 investment with a 10 % yearly interest rate over five years.

For the first year, the compound interest rate is calculated as:

50000 x 10/100 = 5000  (here Rs.5000 is the interest earned for the 1st year)

For second year, the interest rate is calculated as:

Cumulative amount = Principal amount + first year interest earned

  • 50,000 + 5000 = 55,000

Now the interest for the second year is calculated as:

55,000 x 10/100 = 5,500   (here Rs.5,500 is the interest earned for 2nd year)

Similarly, for third year, the interest is calculated as:

Cumulative amount = Principal amount + 1st year interest + 2nd year interest

  • 50000 + 5000 + 5550 = 60,550

Compound interest for the third year is calculated as:

60550 x 10/100 = 6,055   (here Rs. 6,055 is the interest earned for the 3rd year)

In the same fashion, the interest earned for the 4th year = Rs. 6,660.5

For the 5th and final year, interest is = Rs. 7,326.55

Thus, we can see that X has earned a hefty interest of:

5000 + 5550 + 6055 + 6660 + 7326.55 = Rs 30,591.55.

Thus, the total investment for X at the five years is Rs. 50,000 + Rs. 30,591.55

= Rs. 80,591.55

The SIP in mutual funds is the best approach to participate in markets. The longer you remain invested and continue to deposit regular amounts into your account, the more your corpus will grow. You may use a SIP calculator to calculate the monthly payment needed to reach your goal. Understanding compound interest and how it works in finance can assist us in asserting our financial independence. Furthermore, it can teach us financial discipline.