The power of compounding plays a significant role in the investment and wealth-building sector. With proper strategic planning, the power of compounding helps your money to grow manifold, evolving as a reliable avenue for a second income.
What is compound interest?
In compound interest, the interest gets calculated not only on the initial invested amount, but also on the interest gained on it over time. This means that you receive interest upon interest, allowing possibilities of exponential growth over time.
The power of compounding aids your money to grow higher than simple interest, which only gets applied to the principal amount. The frequent the compounding periods are, the higher the growth prospects tend to be.
Compound interest helps in both savings and investments, quickening the overall wealth accumulation rate.
However, if you are dealing with loans and debts, this compounding power might work against you, creating more complications with growing interest rates.
What is a compound interest calculator?
As the name suggests, a compound interest calculator is a digital financial calculator tool used for calculating the total interest earned over a specific initial deposit for a stipulated time, considering the compounding effect. This tool helps you to plan a second income strategy by revealing the nature of growth and the tentative outcome of your investments over time.
By entering the initial investment amount, the rate of interest, compounding intervals, and tenure, you can easily estimate the probable future value of your investment and make a decisive and informed move and proceed accordingly.
This is a very effective and time-efficient method to understand the nature of potential financial growth and plan your investment strategy accordingly.
Advantages of a compound interest calculator
Compound interest calculators are extremely handy and useful tools for both individuals and companies. Some of the most highlighted advantages of this tool include:
- Precise calculation: Since this is a digital tool, it is beyond any human errors. The answers revealed are 100% precise, accurate and reliable.
- Investment planning: This tool helps you in easily calculating the outcome of the investment amount so that you can judge if it is enough to meet your future financial targets.
- Customisable: This is a versatile digital tool where you can enter the numbers based on your circumstances, and make the necessary additions and alterations to fulfil your targets.
- Returns breakdown: This tool allows you to compute the total and annual returns. This proves to be highly useful for strategic financial planning and probable premature withdrawals if needed. However, for that, you must consider the pre-closure charges too, as applicable.
How to use a compound interest calculator?
Although calculating compound interest is a bit tricky mathematical equation, using a compound interest calculator is very easy.
- Gather information: First, decide the principal amount that you desire to invest in a specific fund. Enter that amount, expected yearly rate of interest, and tenure for the fund to grow.
- Enter details: Enter these details on an online compound interest calculating tool.
- Calculation: The tool will automatically calculate the probable outcome of your investment based on the details provided, demonstrating the nature of growth.
The formula for compound interest calculation
For compound interest calculation, you need to follow this formula:
A = P (1+ R/N) ^ nt
Here, A – compound interest
P- Principal amount
R – Interest rate
N- No. of times the interest compounds in a specific year
nt – Total number of years
Frequency of interest compounding
Based on the nature of the fund, the frequency of compounding varies. The popular tenures for interest compounding include:
- Annual compounding: Here, the interest gets calculated only once every year.
- Half-yearly compounding: Here, the interest gets calculated after every 6 months.
- Quarterly compounding: As the name suggests, the interest is calculated every 3 months, i.e., after every quarter.
- Monthly compounding: Here, the interest is calculated every month.
- Daily compounding: Here, the interest gets calculated every single day.
Which is better: daily or monthly compounding?
Although there is no hell and heaven here, it is still best to opt for daily compounding. This is because the calculated interest will be slightly higher, as a shorter compounding interval ensures a higher return.
Difference between simple interest and compound interest
| POINTS OF DIFFERENCE | SIMPLE INTEREST | COMPOUND INTEREST |
| BASIS FOR CALCULATION | Only the principal amount | Principal + accumulated interest |
| FORMULA | SI = (P X R X T)/100 | A = P (1 +r/n) ^ (n x T) |
| GROWTH | Linear | Exponential |
| INTEREST ON INTEREST | Not applicable | Applicable |
| PRINCIPAL AMOUNT | Remains unaltered throughout the tenure | Grows with time with accumulated interest |
| APPLICATIONS | Bonds, short-term loans | Long-term investments, savings accounts |
| RETURNS | Interest is earned only on the initial principal | Earns both on the original principal and the accumulated interest |
Conclusion
A compound interest calculator helps you to set your financial goals well by aiding you in visualising the probable outcome of your investments. You can easily explore various investment avenues and multiple scenarios to choose the best. It offers a clear insight into the outcome of your investment so that you can make the necessary additions and alterations to fulfil your targets over time.
