Compound Interest Formula

Compound interest formula. How to Calculate Compound Interest? Here’s the fastest way.

What is Compound Interest

Compound interest simply means to earn interest on interest. If you were to start off with $100 and receive an interest of 10% per month, after the first month you would have $110, after the second month you would have $121, after the third month you would have $133.10. As you can see, your money increases at an accelerating rate as you earn interest on interest; that is what is meant by the power of compound interest.

How to calculate Compound Interest

You need three numbers in order to calculate compound interest:

1. Principal = the original amount of money invested
2. Rate of interest = the periodic interest received
3. Time period = time period over which interest is allowed to accumulate

Compound Interest Formula

Compound Interest Equations

Here’s the compound interest equation for compound interest calculation:

Formula for Calculating Compound Interest

Compound Interest = Principal x ((1 + Rate of Interest) to the power of the Number of Time periods)

Compound Interest Example

Suppose you invest $10,000 in a ten-year fixed deposit savings account at an annual interest rate of 3%. How much would you have accumulated by the end of the ten years?

How to Compute Compound Interest

Let’s compute the compound interest in this example. Using the compound interest formula, we have the following:

1. Principal = $10,000
2. Rate of Interest = 3% per annum
3. Time period = 10 years

Figuring Compound Interest

Compound Interest = 10,000 x (1.03 ^ 10) = $13439.16

Thus, the compound interest earned in total is $13439.16 – a return of 34% over ten years.

Discounting

Discounting is the opposite of compound interest. This is a way for you to calculate the present value of a sum of money to be received in the future. For example, if you were to receive $100 ten years later, that might only equate to a present value of $88 after we consider the effects of inflation and other factors.

Discounting Formula

Present value = Future Value x ((1 – Discount rate) to the power of the Number of time periods)

In bond investing, the discount rate usually refers to the price of a bond including accrued interest. This is sometimes also known as the ‘dirty price’.

Calculate Compound Interest in Excel

Using the same example as above, it is easy to use Excel to calculate compound interest.

Computing Compound Interest

The formula will then become =10000*POWER(1.03,10)

The first argument in the POWER function is the Interest Rate + 1, the second is the number of periods over which the interest is to be calculated in Excel.

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