{"id":49222,"date":"2024-12-18T10:00:00","date_gmt":"2024-12-18T04:30:00","guid":{"rendered":"https:\/\/www.equentis.com\/blog\/?p=49222"},"modified":"2025-11-07T13:26:40","modified_gmt":"2025-11-07T07:56:40","slug":"compounding-made-clear-formula-and-examples-to-follow","status":"publish","type":"post","link":"https:\/\/www.equentis.com\/blog\/compounding-made-clear-formula-and-examples-to-follow\/","title":{"rendered":"Compounding Made Clear: Formula and Examples to Follow"},"content":{"rendered":"
<\/div>\n

Introduction:<\/h2>\n\n\n\n

If you invest Rs.10,000 in a plan with 10% simple interest for 5 years, you’ll get Rs.15,000 at maturity. But with 10% annual compound interest<\/a>, the same Rs.10,000 grows to Rs.16,105. This example clarifies that compounding<\/a> gives a higher return than simple interest. <\/p>\n\n\n\n

But how?  What is compounding<\/a>? How does it work? Let\u2019s understand with examples of compounding. <\/p>\n\n\n\n

What Is Compound Interest?<\/h2>\n\n\n\n

Compound interest is when interest is calculated on the initial amount you invested and the already added interest. You\u2019re earning interest on your interest. This method makes your money grow faster than if simple interest were applied, which only considers the principal amount. <\/p>\n\n\n\n

In compounding, the principal amount increases every time the accumulated interest is added at a calculation point. This is why compounding is also seen as the plan that gives \u2018interest on interest.\u2019 <\/p>\n\n\n\n

Let\u2019s understand this better with compounding examples. <\/p>\n\n\n\n

Say you invested Rs.1,50,000 for 10 years in a fund with 12% interest compounded annually. After every year, the carried forward amount will gather 12% interest and will result in an output that looks like this in a CAGR calculator<\/a>–<\/p>\n\n\n\n

Year<\/strong><\/td>Principal for the year (Rs.)<\/strong><\/td>Interest <\/strong>(at 12%)<\/strong><\/td>Amount carried forward (Rs.)<\/strong><\/td><\/tr>
1<\/td>1,50,000<\/td>18,000<\/td>1,68,000<\/td><\/tr>
2<\/td>1,68,000<\/td>20,160<\/td>1,88,160<\/td><\/tr>
3<\/td>1,88,160<\/td>22,579.20<\/td>2,10,739.20<\/td><\/tr>
4<\/td>2,10,739.20<\/td>25,288.70<\/td>2,36,027.90<\/td><\/tr>
5<\/td>2,36,027.90<\/td>28,323.35<\/td>2,64,351.25<\/td><\/tr>
6<\/td>2,64,351.25<\/td>31,722.15<\/td>2,96,073.40<\/td><\/tr>
7<\/td>2,96,073.40<\/td>35,528.81<\/td>3,31,602.21<\/td><\/tr>
8<\/td>3,31,602.21<\/td>39,792.26<\/td>3,71,394.47<\/td><\/tr>
9<\/td>3,71,394.47<\/td>44,567.34<\/td>4,15,961.81<\/td><\/tr>
10<\/td>4,15,961.81<\/td>49,915.42<\/td>4,65,877.23<\/td><\/tr>
<\/td>Total Interest <\/strong><\/td>3,15,877<\/strong><\/td><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

In this compounding example, the interest of the first year, Rs.18,000, is added to the principal amount for the second year, and the interest is computed again on the entire sum of Rs.1,68,000. The process is carried out for the whole tenure of the plan or fund. This is compound interest.<\/p>\n\n\n\n

Instead of the table, a more direct way of calculating compound interest is by using the compound interest formula-<\/p>\n\n\n\n

Compound Interest = Total Amount – Principal<\/p>\n\n\n\n

where,<\/p>\n\n\n\n

Amount = P (1 + r\/n) ^ nt<\/p>\n\n\n\n

In this, \u2018r\u2019 stands for the rate of interest divided by 100, \u2018n\u2019 represents the tenure in years, \u2018t\u2019 stands for the frequency of compounding, and \u2018P\u2019 is the principal. <\/p>\n\n\n\n

According to the formula, if we substitute the value of the same example, that is <\/p>\n\n\n\n