What is Compound Interest?
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Often called the "eighth wonder of the world," it causes wealth to grow exponentially over time rather than linearly.
For example, ₹1 lakh at 10% compound interest for 10 years grows to approximately ₹2.59 lakh, compared to just ₹2 lakh with simple interest.
Compound Interest Formula
A = P × (1 + r/n)^(n×t)
Where:
A = Final Amount
P = Principal
r = Annual Interest Rate (÷ 100)
n = Compounding Frequency per Year
t = Time in Years
Common values of n:
Annually = 1, Quarterly = 4, Monthly = 12, Daily = 365
Compounding Frequency Matters
- The more frequently interest compounds, the higher the final amount.
- Monthly compounding yields more than annual compounding at the same rate.
- Over long periods, even a small increase in frequency has a significant impact.
Real-World Examples
- FDs and RDs compound quarterly or monthly.
- PPF and EPF compound annually.
- Mutual fund returns are effectively compounded daily through NAV growth.
