What is Compound Interest?
financeDefinition
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Often called 'interest on interest', it causes wealth to grow exponentially. The formula is: A = P × (1 + r/n)^(nt), where P is principal, r is annual rate, n is compounding frequency, and t is time in years.
Detailed Explanation
The quote that Albert Einstein called compound interest the 'eighth wonder of the world' is almost certainly apocryphal, but the idea behind it holds. The power of compounding is demonstrated by the Rule of 72: divide 72 by your annual return rate to find how many years it takes to double your money. At 12% returns, money doubles approximately every 6 years.
Compound interest works against you in loans (you pay interest on unpaid interest) but works in your favor in investments. This is why starting to invest early — even with small amounts — produces dramatically better outcomes than investing larger amounts later.
Compare compound vs. simple interest for any investment using ToolsDock's Interest Calculator.
Compound versus simple interest: a worked example
Invest ₹1,00,000 at 8% a year for 10 years. With simple interest you earn ₹8,000 every year, so the total is ₹1,80,000. With annual compounding the amount becomes ₹1,00,000 × 1.08¹⁰, which is about ₹2,15,900. The extra ₹35,900 is interest earned on earlier interest.
How often interest compounds also matters. At the same 8% rate, quarterly compounding takes the ten-year total to about ₹2,20,800. The difference between frequencies is small compared with the effect of time and rate, but it is why two products with the same headline rate can pay slightly different amounts.
The Rule of 72 and what it tells you
Divide 72 by the annual rate to estimate the doubling time. At 8%, money doubles in about 9 years. At 12% it takes about 6 years. It is a mental shortcut, accurate for typical rates between 6% and 12%, and the Interest Calculator gives the exact figure.
The rule also works in reverse for debt. A credit card charging 36% a year roughly doubles an unpaid balance in two years, which is why revolving card debt is so costly.
Where compounding shows up in your money
Fixed deposits, PPF, recurring deposits and mutual fund growth options all compound. Loans compound against you too, although for regular EMI loans the effect is managed through the amortization schedule. Credit cards and missed payments are where compounding hurts most.
Two habits help compounding work for you: start early, because time is the strongest input, and avoid withdrawing growth. A SIP is a simple way to feed the compounding engine on a regular schedule.
📈 Compound Interest Calculator
Simple & compound interest calculator