What is compound interest?
With compound interest, the interest you earn is added to your balance and itself earns interest in the next period. Over long periods this snowballs: the longer the money stays invested, the faster it grows. Simple interest, by contrast, is always calculated on the original amount only.
Compound interest formula
A = P × (1 + r ÷ n)^(n × t)
- A = final amount
- P = principal
- r = annual interest rate (as a decimal, 8% = 0.08)
- n = times interest is compounded per year
- t = time in years
- Compound interest = A − P
Example: ₹1,00,000 at 10% compounded yearly for 5 years grows to ₹1,61,051. Simple interest at the same rate gives only ₹1,50,000 — compounding adds ₹11,051.
How compounding frequency changes the result
| Compounding | Maturity value | Interest |
|---|---|---|
| Simple interest | ₹1,80,000 | ₹80,000 |
| Yearly | ₹2,15,892 | ₹1,15,892 |
| Half-yearly | ₹2,19,112 | ₹1,19,112 |
| Quarterly | ₹2,20,804 | ₹1,20,804 |
| Monthly | ₹2,21,964 | ₹1,21,964 |
The more often interest is compounded, the more you earn — but the biggest jump is from simple to compound interest, not between frequencies.
Adding monthly deposits
Regular deposits make compounding far more powerful. ₹1,00,000 at 8% (compounded yearly) plus ₹2,000 every month for 10 years: you put in ₹3,40,000 and it grows to about ₹5,76,141.
The Rule of 72
A quick mental check: divide 72 by the annual interest rate to estimate how many years it takes to double your money. At 8% it takes about 9 years; at 12%, about 6 years.
Where compound interest applies
- Fixed deposits — compounded quarterly by Indian banks.
- PPF — compounded yearly.
- Recurring deposits — monthly deposits, compounded quarterly.
- Mutual funds and stocks — no fixed rate, but long-term growth compounds in the same way.
- Loans and credit cards — compounding works against you here; unpaid credit card dues compound monthly at very high rates.
Compound vs simple interest over time
| Years | Simple interest | Compounded yearly |
|---|---|---|
| 5 | ₹1,50,000 | ₹1,61,051 |
| 10 | ₹2,00,000 | ₹2,59,374 |
| 20 | ₹3,00,000 | ₹6,72,750 |
| 30 | ₹4,00,000 | ₹17,44,940 |
The gap widens every year: after 30 years compounding gives more than four times what simple interest does. Starting early matters more than investing a little more later.
Frequently asked questions
What is the formula for compound interest?
A = P × (1 + r/n)^(n × t), where P is the principal, r the annual rate as a decimal, n the compounding periods per year and t the years. Compound interest = A − P.
What is the difference between simple and compound interest?
Simple interest is calculated only on the original principal. Compound interest is calculated on the principal plus the interest already added, so it grows faster over time.
Which is better: monthly or yearly compounding?
For savings, monthly compounding earns slightly more than yearly at the same rate. On ₹1 lakh at 8% for 10 years, monthly gives ₹2,21,964 against ₹2,15,892 yearly.
How long does it take to double money at 8%?
About 9 years, by the Rule of 72 (72 ÷ 8). Compounded yearly, ₹1 lakh becomes ₹1,99,900 in 9 years.