Compound interest can be described as the interest earned on interest. Typically, an investor accrues compound interest when they earn interest on invested amount and the interest accumulated.
Often when a large amount of money is involved over a longer investment tenure, the interest calculation gets complex. This is where using a compound interest calculator can prove helpful.
Such a tool offers accurate results in seconds and makes determining compound interest on investments like mutual funds easier. In turn, this helps save time and energy.
What is a Compound Interest Calculator?
A compound interest calculator is a financial tool that can be readily accessed from any leading financial website. The tool has inbuilt scientific formulas that help compute compound interest instantly.
Such a tool allows users to check their estimated returns on investment instruments such as mutual funds or fixed deposits with compound interest. It also comes in handy in financial planning by offering an insight into the estimated maturity amount, which helps one understand whether the financial instrument will help them achieve their goals.
Requisites of Using a Compound Interest Calculator
When analyzing one’s investment maturity value, one can use a compound interest calculator to eliminate the need for manual calculations.
Typically, investors would need a few details to ascertain the returns on their investments.
In other words, individuals would need to enter these into a compound interest calculator to know the returns on investment and the maturity amount:
- Invested amount
- Rate of interest
- Investment tenure
That said, let’s check how a compound interest calculator works to provide maturity value.
How Compound Interest Calculator Works
A compound interest calculator uses its inbuilt compound interest formula to compute the interest amount.
To break it down, the compound interest formula has three variables –
- Principal (P)
- Rate (R
- Compounding Frequency (N)
N is the number of times the interest compounds. Usually, the compounding frequency varies among investments. To streamline the same, compound interest calculators offer the option to select from monthly, quarterly, half-yearly, and yearly options.
Compound Interest Formula
The compound interest formula has three variables and can help determine interest amount and maturity amount easily.
Take a look at the formula given below –
P is the principal amount
R is the rate of interest
n is the compounding frequency per year
N is the total compounding frequency for the invested period
Compound Interest Calculation Example
Compound interest calculation can be complex as it involves several variables and has multiple steps.
Let’s take a look at the example below to understand how it works.
Say, Alia invested Rs. 5,00,000 in a fixed deposit account that compounds interest rate quarterly basis. The FD offers 5% annually, and Alia decides to open the account for 5 years.
After 5 years, the interest amount and maturity amount, as per the formula, will be –
As per the formula,
- Principal (P) is ₹5,00,000
- The rate of interest (R) is 0.05 (or 5%)
- Compounding frequency (n) = 4
- Total compounding frequency (N) = 20 (5 years x 4 times/year)
The accrued compound interest:
There are several steps involved in computing the compounding interest on the fixed deposit. However, using an online compound interest calculator, you can determine the maturity amount and interest within seconds. The formula is already fed into the calculator’s system which makes it easier to compute compound interest quickly.
This will save time and also lower the chances of errors common in manual calculations.
Compounding Frequency in Compound Interest Calculation
What sets investments with compounding interest apart from the rest is that, over time, the effects of compounding get more pronounced.
This is because the interest earned over prior periods gets added to the invested amount, in turn increasing it. The subsequent interest on the higher principal amount generates higher interest.
The longer the principal is left invested, the bigger will be the corpus and the accrued interest.
This is how the power of compounding works in favor of investors and helps generate greater returns. However, this is not as simple as it sounds, and it requires multiple levels of calculations before reaching the maturity amount.
Thanks to compound interest calculators, users don’t have to compute manually to understand each calculation level.
However, to ensure you make the most of such a tool, you must know how to use it in the first place.
Steps to Use Compound Interest Calculator
One can access an online compound interest calculator from any leading financial website.
Usually, the tool is easy to use and doesn’t involve too many steps, to begin with.
Here’s how most compounding interest calculators can be used –
Step 1: Open an online compound interest calculator
Step 2: Enter the variables – principal, rate of interest, and holding period at designated fields
Once the details are entered, the compound interest calculator will show the interest amount and the maturity amount you will likely get at the end of the investment tenure.
The best thing about an online compound interest calculator is that you can make multiple adjustments to it and tweak the interest rate, principal, or tenure to see which combination works best. This will help you plan your investment accordingly and align the same to meet your financial goals. Note that different financial tools have designated calculators to help users find their returns on investments with greater ease. For instance, a PPF calculator or a Fixed Deposit calculator makes it easier to compute their respective returns with custom settings.
Benefits of a Compound Calculator
Here are the key benefits of a compound interest calculator:
- Simplifies the calculation of compound interest on investments
- Eliminates the need for manual calculation
- Eliminates errors common in a long, complex calculation
- It helps plan investments better
- It helps understand the power of compounding on the invested amount
- Allows multiple adjusts on the calculator to facilitate financial planning
- Facilitates easy comparison between different investment plans and helps choose one that produces higher returns that matches their financial goals
This is how a compound interest calculator proves useful for individuals who wish to know their maturity amount and determine the power of compounding on their invested sum. Knowing the basics of such a tool can help use it to plan finances better and strengthen existing financial planning.