Introduction
The main purpose of any type of savings is either earning regular returns or gradually building a corpus fund that can be used to meet the long-term financial goals. The returns generated on any investment can be in the form of dividends or interest that may be received at fixed intervals or reinvested in the investment fund to generate more returns.
When the investor reinvests the interest income, they are essentially earning more returns on their income already earned. This is the basic premise of compounding where money generates more money. Compounding is the easiest and the fastest way to build a corpus fund. Most dynamic investment products rely on the concept of compounding to maximize investor’s wealth. Compound interest is calculated at many intervals like daily compounding, monthly compounding, quarterly compounding, half-yearly compounding, and yearly compounding.
However, it may often be difficult for an average investor to calculate the exact fund value to be received upon maturity based on such compound interest investing. This is where a compound interest calculator can be quite helpful.
Given below are a few details of the compound interest calculator and the need for the same.
Table of Contents
What is a compound interest calculator?
A compound interest calculator is a simulation or a financial tool that can be used to calculate the compounded interest and the accumulated wealth at the end of the tenure at the specified rate of interest. This mathematical tool drastically reduces the efforts of the investors to calculate the accumulated amount at the end of the tenure for any investment. It also helps them work out many permutations and combinations of the amount to be invested to meet their target financial goals. This tool is available on the website of lenders or other portals that assist in making sound investments on behalf of the investors.
How does a compound interest calculator work?
We have discussed the meaning of the compound interest above. Let us now understand how it works. For this, we can take a basic example of an investment of Rs. 1,00,000 which is invested for 5 years at an annual compounded interest rate of 10%. The amount of interest and the final value of the investment value is shown in the table below.
| Year | Amount invested at the start of the year | Interest rate | Interest amount | Investment value at end of the year |
|---|---|---|---|---|
| 1 | 100000 | 10% | 10000 | 110000 |
| 2 | 110000 | 10% | 11000 | 121000 |
| 3 | 121000 | 10% | 12100 | 133100 |
| 4 | 133100 | 10% | 13310 | 146410 |
| 5 | 146410 | 10% | 14641 | 161051 |
| Total | 61051 |
From the above example, we can see that the investor has earned net earnings of Rs. 61,051 on the initial investment of Rs. 1,00,000.
The above example was quite basic but in the real world, these calculations can run into pages when the investment is long-term and the compounding factor is daily or monthly. It can become quite cumbersome for the investors to calculate the compounded value of an investment in such cases.
Compound interest calculators can be a huge help in such cases. Investors have to simply provide certain basic inputs in such calculators to get the final value of the investment at the end of the tenure.
Formula for Compound Interest Calculation
As mentioned above, a compound interest calculator requires the investors to provide few basic parameters for getting the final fund value. The basic formula to calculate the compounded interest is:
A = P(1+r/n) ^ nt
Where
- A = Final amount at the end of the term
- P = Principal amount or initial investment
- r = compounding rate of interest
- n = compounding frequency per year
- t = number of years in the tenure
If we consider the above example again, the final amount will be derived in the following manner.
A = 100000(1+0.10/1)^1*5
A = Rs. 1,61,051
The amount of interest earned over the years is Rs. 61,051.
How to use Fisdom’s compound interest calculator?
The Fisdom website provides the compound interest calculator for the investors to easily calculate the value of their investment at the end of the tenure. The investors have to simply provide the following parameters to get the desired value.
- Initial investment or the principal amount
- Rate of interest
- Period of investment
- Frequency of compounding
The compound interest calculator will immediately display the final value of the investment and the compound interest earned over the specified period.
What are the advantages of compound interest calculator?
There are multiple advantages of the compound interest calculator. Some of such advantages are highlighted below.
- Reduces the efforts of the investors and provides the compounded value of investment immediately within seconds
- Allows the investors to try various combinations of the basic parameters to meet their financial goals in the optimum manner that suits them best.
- Provides information about the interest that can be earned at the end of the tenure to plan their finances better.
- Helps the investors in making sound investment decisions by choosing the better investment option among the various available options.
Conclusion
When the investors have the option to choose between simple interest and compound interest investment options, it is always better to go for the compounded interest option. Investing in a compounded interest scheme allows the investors to get better returns as compared to simple interest options. This helps them achieve their investment targets faster and eventually have better financial planning.
FAQs
There are several compounding options available for any investment which
are mentioned below,
- Daily compounding
- Monthly compounding
- Quarterly compounding
- Half-yearly compounding
- Yearly compounding or annual compounding
Some examples of the investments that use compounding interest option are bank savings accounts, cumulative Bank FDs, mutual fund investments (growth option, dividend reinvestment option), ULIPs, etc.
The general rule regarding the frequency of compounding is that the higher the frequency of compounding, the higher are the returns earned.
The formula for simple interest is
Amount = Principal * rate of interest * tenure
- Invest early
- Invest regularly
- Increase the tenure of investment
- Increase the frequency of compounding
