Compound Interest Calculator
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Understanding Compound Interest
Compound interest, often called "interest on interest," is a powerful concept in finance that can significantly accelerate the growth of your investments over time. Unlike simple interest, which is calculated only on the initial principal amount, compound interest is calculated on the initial principal plus all the accumulated interest from previous periods.
How it Works
Imagine you invest $1,000 at an annual interest rate of 5%. If interest is compounded annually:
- Year 1: You earn 5% of $1,000, which is $50. Your total is now $1,050.
- Year 2: You earn 5% of $1,050, which is $52.50. Your total is now $1,102.50.
- Year 3: You earn 5% of $1,102.50, which is $55.13. Your total is now $1,157.63.
As you can see, the amount of interest earned increases each year because the base on which the interest is calculated grows. This creates a snowball effect, leading to exponential growth.
The Formula for Compound Interest
The future value of an investment with compound interest can be calculated using the following formula:
FV = P (1 + r/n)^(nt)
Where:
- FV = Future Value of the investment/loan, including interest
- P = Principal investment amount (the initial deposit or loan amount)
- r = Annual interest rate (as a decimal)
- n = Number of times that interest is compounded per year
- t = Number of years the money is invested or borrowed for
Factors Affecting Growth
- Principal Amount: A larger initial investment will naturally yield a larger future value.
- Interest Rate: Higher interest rates lead to faster growth.
- Time: The longer your money is invested, the more time compounding has to work its magic. Even small differences in time can have a significant impact.
- Compounding Frequency: The more frequently interest is compounded (e.g., daily vs. annually), the slightly higher the final amount will be, though the effect diminishes as frequency increases significantly.
This calculator helps you visualize how these factors interact to determine the potential growth of your investments through the power of compounding.