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

Equity investors should track market developments

The stock markets have been volatile over the last few days. They are in a sideways movement and trying to find the bottom after a fall of 20 percent a week ago. The market sentiments are not very positive at the moment and the recent developments are expected to dampen them further. Globally, governments and central banks are trying to cut rates and announce packages to improve business sentiments. These are some of the major developments in the markets last few month: A) Global On the global front, another large US bank went into a financial crisis. The US government took quick measures to avoid the spread negative sentiments in the markets. The US government announced a bail-out package and agreed to shoulder the losses on the bank's risky assets. China announced a large cut in interest rates and reserve ratio to boost the investor sentiments in the markets. Recently, the World Bank announced China's growth rate next year will come down to 7.5 percent. The European ...
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

Gold: It is safe & secure

RETURNS ON GOLD & ITS ETF’s RISE WHILE most of the popular asset classes are going through bad times, the yellow metal shines on. In fact, in the last one year, gold has given a return of more than 25% and currently trades at Rs 14,695 per 10 gm. Even gold exchange traded funds ( ETFs ) have appreciated substantially. Gold Gold Benchmark Exchange Traded Scheme ( BeES ) and Kotak Gold ETF have given more than 25% returns each in the last three months. Even as the equity markets have taken a hit with the Sensex losing around 46% in the last one year and real estate prices also witness a correction, investors’ preference has shifted to safe havens such as gold. On an average, most of the diversified equity mutual funds have fallen and real estate developers are offering discounts. Thus gold remains the safest bet. The appreciation in the gold prices is mainly due to its safe haven status. The key reason for gold to go up is lack of other investment opportunity. There is also a risk in...
Read more

Alpha - The relative performance

Alpha, the net performance of a component against the benchmark is an overlooked tool   Absolutely speaking, any bounce back now on markets should be the last for the year. We offcourse can be wrong and prefer to be judged on alpha (relative performance) as relative accountability is fine with us. According to Alpha India, the top outperformers in the weeks ahead should be Reliance Communications, Reliance Infrastructure, SBI, HDFC, ONGC, Larsen, Jaiprakash Associates, Maruti, Bharti and DLF. On the short side (reduce side), we have Ranbaxy, ACC, Sail, Tata Steel, Wipro, Tata Motors, Sun Pharma, TCS, M&M and Infosys.   Performance like everything follows the 80-20 rule, 80 per cent of your gains are going to come from 20 per cent of your portfolio. So why not give it a thought? The importance of alpha If alpha was so important, then why don ' t newspapers and websites publish it? Why alpha gets featured annually but not as intraday or daily event? Why don ' t we c...
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