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What is Compound Interest?

03 Sep 2021 by IDFC FIRST Bank
What is compound interest

A brief understanding of Compound Interest and the power of compounding


Compound interest is essentially a type of return with which your savings can see a good amount of growth. More complicated than simple interest, compound interest is an important factor to consider when you’re getting returns on your savings or deposit. Let us learn more about what is compound interest, what is the formula of compound interest and what it does to your money in the long run.

What is compound interest?


Compound interest is interest earned on interest. Compounding occurs when you earn returns on the principal amount and the interest previously earned. In an account where you are earning simple interest, you only get interest on the principal amount. An account that offers compound interest allows interest to be earned over not just the principal, but also the interest you may have earned.

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What is the formula of compound interest?


Compound interest can be confounding for a first-time reader. Let us try to simplify it with its mathematical formula and then, with the help of an example:

The compound interest formula is:

A = P (1 + (r/n)) ^ nt

Where,

A = final amount you will receive

P = the initial principal amount

r = interest rate

n = number of times interest is applied

t = time passed (in years)

Now, let us look at a simple example to understand it better and to see how compounding benefits you. Suppose Ajay opened a bank account with an institution that offered a monthly compound interest of 4%. For convenience, let us assume Ajay is not depositing or withdrawing any money from this account for some time.

After the first month, Ajay's bank account was credited with ₹1200 on the current balance of ₹30,000. In the next month, he earned an interest amount of ₹1248. This interest was not drawn on the principal amount (₹30,000) but on the interest plus the principal amount, which was ₹31,200. In the third month, he earned an interest amount of ₹1297, and so on.

On an account offering a simple interest rate, Ajay would have earned only ₹1200 each month.

Many investment instruments use compounding to multiply your money. Mutual funds are one of them, and you can invest in any mutual fund of your choice on IDFC FIRST Bank. You can also select whether you want to invest in equity funds, tax-saving funds, or hybrid funds. We, additionally, have an SIP calculator to help you structure your mutual fund investments the right way. You can set a goal and use the calculator to know how to achieve it through mutual fund investments.

Compounding allows you to earn interest from the principal amount and the interest previously generated on this amount. The interest earned becomes a part of the principal, on which the future interest will be drawn.

 

What is the compounding rate of interest usually?


The rate of interest differs from bank to bank. The compounding rate of interest may also depend upon the type of bank account that you have. IDFC FIRST Bank recently launched monthly interest pay outs on savings accounts. It means that with opening a savings account with IDFC FIRST Bank, you will receive a monthly interest credit on your account balance. And this interest will also be compounded. So, not only will you be saving funds, you will grow your savings with this account. Know more.

Now that you know what is compound interest, and what is the formula of compound interest, make the best of it and save your money where you can earn interest via compounding. Begin by exploring investment instruments that use compounding to grow your money over time.

 

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.