Skip to main content

How Compound Interest works?

 
Personal Finance article in Advisorkhoj - How Compound interest works

Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it. - Albert Einstein

In our previous article we discussed the benefits of start investing early for wealth creation and we also discussed how it is possible using 'power of compounding'. Now, let's understand how Compound Interest works in your favour?

Compound interest is the concept of adding earned or accumulated interest back to the principal amount, so that interest is earned on top of interest from that period onwards. The act of adding declared interest to be principal is called compounding.

It is similar to simple interest (in simple interest, the interest portion in not added to the principal) but, here the interest will be added to the principal after a certain unit of time (e.g. Monthly, Quarterly, Half – yearly and Annually etc.). Example – a savings of Rs.10,000 at 10% annual interest will become 11,000 after 12 months. Here, the interest amount is Rs.1,000. But, the interest amount after 24 months would be Rs.1,100 as at the end of 24 month the Interest is calculated on Rs.11,000 (i.e. Rs.10,000 + Rs. 1,000 – Interest earned in the 1st Year)! This is possible as the interest will be paid both on the principal and on the interest that has been added to it. In other words, we can say, interest itself earns interest!

The compounding period and the frequency of compounding apart from the interest rate are the major components of compound interest calculation. The frequency (Annual, Half-year, Quarter or month) after which an interest earned during that period added to the principal is called as compounding period. Now, let's understand these with formulas on different compound periods.

When the interest is compounded annually then the following formula will be used to calculate the yearly compounding interest –

Personal Finance - Yearly compounding interest formula

When the interest is compounded half - yearly then the following formula will be used to calculate the half-yearly compounding interest –

Personal Finance - Half-yearly compounding interest formula

When the interest is compounded quarterly then the following formula will be used to calculate the Quarterly compounding interest –

Personal Finance - Quarterly compounding interest formula

When the interest is compounded monthly then the following formula will be used to calculate the monthly compounding interest –

Personal Finance - Monthly compounding interest formula

In the above formula the P denotes the Principal amount. R denotes the percentage of interest and n denotes the time in years or months (n means annual, 2n means half-year, 4n means quarter and 12n means monthly).

Now, let's understand 'how to calculate and get the results in excel'? The following shows the result of Rs.10,000 invested at 10% interest for 5 years at different compounding periods.

Result of annual compounding

Personal Finance - Result of annual compounding

Result of half-yearly compounding

Personal Finance - Result of half-yearly compounding

Result of quarterly compounding

Personal Finance - Result of quarterly compounding

Result of monthly compounding

Personal Finance - Result of monthly compounding

Hope, you find that above useful.

-----------------------------------------------
Invest Rs 1,50,000 and Save Tax under Section 80C. Get Great Returns by Investing in Best Performing ELSS Mutual Funds

Top 10 Tax Saving Mutual Funds to invest in India for 2016

Best 10 ELSS Mutual Funds in india for 2016

1. BNP Paribas Long Term Equity Fund

2. Axis Tax Saver Fund

3. Franklin India TaxShield

4. ICICI Prudential Long Term Equity Fund

5. IDFC Tax Advantage (ELSS) Fund

6. Birla Sun Life Tax Relief 96

7. DSP BlackRock Tax Saver Fund

8. Reliance Tax Saver (ELSS) Fund

9. Religare Tax Plan

10. Birla Sun Life Tax Plan

Invest in Best Performing 2016 Tax Saver Mutual Funds Online

Invest Online

Download Application Forms

For further information contact Prajna Capital on 94 8300 8300 by leaving a missed call

---------------------------------------------

Leave your comment with mail ID and we will answer them

OR

You can write to us at

PrajnaCapital [at] Gmail [dot] Com

OR

Leave a missed Call on 94 8300 8300

-----------------------------------------------

Popular posts from this blog

All about "Derivatives"

What are derivatives? Derivatives are financial instruments, which as the name suggests, derive their value from another asset — called the underlying. What are the typical underlying assets? Any asset, whose price is dynamic, probably has a derivative contract today. The most popular ones being stocks, indices, precious metals, commodities, agro products, currencies, etc. Why were they invented? In an increasingly dynamic world, prices of virtually all assets keep changing, thereby exposing participants to price risks. Hence, derivatives were invented to negate these price fluctuations. For example, a wheat farmer expects to sell his crop at the current price of Rs 10/kg and make profits of Rs 2/kg. But, by the time his crop is ready, the price of wheat may have gone down to Rs 5/kg, making him sell his crop at a loss of Rs 3/kg. In order to avoid this, he may enter into a forward contract, agreeing to sell wheat at Rs 10/ kg, right at the outset. So, even if the price of wheat falls ...
Read more

ICICI Prudential Balanced Fund

 ICICI Prudential Balanced Fund scheme seeks to generate long-term capital appreciation and current income by investing in a portfolio that is investing in equities and related securities as well as fixed income and money market securities. The approximate allocation to equity would be in the range of 60-80 per cent with a minimum of 51 per cent, and the approximate debt allocation is 40-49 per cent, with a minimum of 20 per cent. An impressive show in the last couple of years has propelled this fund from a three-star to a four-star rating. The fund has traditionally featured a high equity allocation, hovering at well over 70 per cent, which is higher than the allocations of the peers. But in the last one year, the allocation has been moderated from 78-79 per cent levels to 66-67 per cent of the portfolio. ICICI Prudential Balanced Fund appears to practise some degree of tactical allocation based on market valuations. Within equities, well over two-thirds of the allocation is parked i...
Read more

Tax Planning: Income tax and Section 80C

In order to encourage savings, the government gives tax breaks on certain financial products under Section 80C of the Income Tax Act. Investments made under such schemes are referred to as 80C investments. Under this section, you can invest a maximum of Rs l lakh and if you are in the highest tax bracket of 30%, you save a tax of Rs 30,000. The various investment options under this section include:   Provident Fund (PF) & Voluntary Provident Fund (VPF) Provident Fund is deducted directly from your salary by your employer. The deducted amount goes into a retirement account along with your employer's contribution. While employer's contribution is exempt from tax, your contribution (i.e., employee's contribution) is counted towards section 80C investments. You can also contribute additional amount through voluntary contributions (VPF). The current rate of interest is 8.5% per annum and interest earned is tax-free. Public Provident Fund (PPF) An account can be opened wi...
Read more

Fortis Mutual Fund

Fortis Mutual Fund, a relatively new player, it is still to prove its case and define its position in the industry. In September 2004, it came onto the scene with a bang - three debt schemes, one MIP and one diversified equity scheme. And investors flocked to it. Going by the standards at that time, it had a great start in terms of garnering money. Mopping up over Rs 2,000 crore in five schemes was not bad at all. The fund house has not been too successful in the equity arena, in terms of assets. Though it has seven equity schemes, it is debt and cash funds that corner the major portion of the assets. Most of the schemes are pretty new, and the two that have been around for a while have a 3-star rating each. The last two were Fortis Sustainable Development (April 2007), which received a rather poor response, and Fortis China India (October 2007). Fortis Flexi Debt has been one of the better performing funds, after a dismal performance in 2005. It currently has a 5-star rating. None ...
Read more

PF e-Passbook

  Provident Fund e-Passbook   The Employees Provident Fund Organisation now runs an e-passbook service that enables members to log in and access their provident fund accounts . This facility enables tracking of the money and ensuring that the employer's contribution has been deposited into the account. This facility is available to those whose accounts are with the central provident fund commissioner for maintenance and can be availed at members.epfoservices.in . Registration A member can register at the portal easily by using PAN , Aadhar or passport number as the log in and the mobile numbers as the PIN . This combination enables easy retrieval of information. Accounts After logging in, the member has to choose the state where the employer is located, and enter the code number of the employer, account number and name. These details can be obtained from any existing PF document . PIN To download the passbook, the member will request...
Read more
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now