Compound Interest: Definition, Concepts, Formula, Examples
Subham Sahoo8 Nov, 2025
Compound Interest: It is one of the important concepts in finance and helps in understanding how savings increase over time. Compound Interest is often referred to as the “interest on interest” because it helps the money grow on the amount invested and also the interest earned.
Compound Interest Overview
Compound Interest refers to the process of calculating interest where interest can be earned on both the original amount (called the principal) and the interest that has already been added.
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Over time, compound interest leads to faster growth in comparison to Simple Interest, which only provides returns on the principal.
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Compound Interest is used by all banking, financial institutions, and investors to calculate the growth of money in savings accounts, fixed deposits, and investments.
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The more time the money stays invested, the more it grows because the interest keeps adding up.
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For example, if someone invests ₹5,000 in a savings account that pays interest every year, next year, he/she will earn interest not only on ₹5,000 but also on the interest they earned in the first year.
Compound Interest Formula
The formula to calculate Compound Interest is:
A = P [1 + R/100)T
Where,
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A = Total amount after time T
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P = Principal (the original money invested)
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R = Rate of interest per year
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T = Time in years
The Compound Interest itself can be found by subtracting the principal from the total amount:
Compound Interest = Amount (A) - Principal (P)
Difference Between Simple and Compound Interest
Several people confuse Simple Interest and Compound Interest, but they are not the same. The main difference between the types of interests lies in the calculation of interest over time. The table below provides a comparison between Simple Interest and Compound Interest:
| Difference Between Simple and Compound Interest | ||
| Particulars | Simple Interest | Compound Interest |
| Meaning | Interest is calculated only on the original principal. | Interest is calculated on both the principal and the accumulated interest. |
| Growth Type | Linear growth (increases by the same amount every year). | Exponential growth (increases faster over time). |
| Formula | SI = (P × R × T) / 100 | A = P [1 + R/100)T |
| Return | Lower returns. | Higher returns over long periods. |
| Usage | Short-term loans and simple savings. | Long-term investments, savings accounts, and compounding schemes. |
How to Calculate Compound Interest?
Calculating Compound Interest is when the formula is known. However, the frequency of compounding also matters. The more frequently the interest is added, the faster your money grows. Interest can be compounded in the following ways:
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Annually (once a year)
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Semi-annually (twice a year)
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Quarterly (four times a year)
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Monthly (twelve times a year)
The general formula when compounding happens more than once a year is:
A = P [1 + R/100n)nT
Where n = Number of times interest is compounded per year
Benefits of Compound Interest
Compound Interest has many benefits, especially for long-term investors and savers. Here are some of its key advantages:
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Faster Growth: Your money grows much faster compared to simple interest because of the “interest on interest” effect.
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Encourages Long-Term Saving: The longer you keep your money invested, the more it grows. This teaches the value of patience and consistent saving.
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Suitable for All Investors: Whether you are a student saving pocket money or an adult planning for retirement, Compound Interest helps you grow wealth over time.
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Helps Beat Inflation: Since your returns increase with time, compounding helps your money maintain its value even when prices rise.
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Power of Time: The biggest advantage of compounding is time. Even small amounts can turn into big sums if left to grow for many years.
Compound Interest Examples
Some of the examples of Compound Interest in the real-life situations are as follows:
Example 1:
Ravi invests ₹10,000 in a bank account at 5% annual interest for 3 years.
A = 10,000 + (1 + 5/100)3 = 10,000 (1.05)3 = 11,576.25
Compound Interest = ₹11,576.25 - ₹10,000 = ₹1,576.25
Example 2:
Priya invests ₹8,000 at 8% interest compounded semi-annually for 2 years.
A = 8,000 + (1 + 8/2*100)2*2 = 8,000 (1.04)4 = 9,351.42
Compound Interest = ₹9,351.42 - ₹8,000 = ₹1,351.42
Example 3:
Aman deposits ₹12,000 at 10% interest compounded quarterly for 3 years.
A = 12,000 + (1 + 10/4*100)4*3 = 12,000 (1.025)12 = 9,351.42
Compound Interest = ₹16,116.55 - ₹12,000 = ₹4,116.55