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Compound interest is the concept of adding accumulated interest back to the principal sum, so that interest is earned on top of interest from that moment on. The act of declaring interest to be principal is called compounding.
Financials institutions vary in terms of their compounding rates - daily, monthly, yearly, etc. As an example, a savings account with $1000 principal and 10% interest per month would have a balance of $1100 at the end of the first month. By the end of the second month, the $1100 amount would have received 10% more, making $1210... and so on...
You can learn more about compound interest in our dedicated article. If you want to work out how long it will take you to achieve a savings goal with regular monthly payments, see the article how long will it take me to save?.
Our compound interest calculators allow you to compound interest on either a daily, monthly, quarterly, half yearly or yearly basis. Your savings account may vary on this, so you may wish to check with your bank or financial institution to find out which frequency they compound the interest on your savings.
So what difference does the frequency of compounding make to your savings calculation? The line graph below demonstrates the compounding effect of varying frequencies on an initial investment of $1000 with a 20% annual interest rate.
With savings accounts, interest can be calculated at either the start or the end of the compounding period (month or year). With my savings calculators, additions are made at the start of each compounding period.
Annual Compound Interest Formula:
V = P(1+r/n)(nt)
The popular formula for calculating annual compound interest is V = P(1+r/n)(nt)
V = the future value of the investment
P = the principal investment amount
r = the annual interest rate
n = the number of times that interest is compounded per year
t = the number of years the money is invested for
You can learn more about the compound interest formula, and try out an interactive formula calculation tool, in our article dedicated to the formula for compound interest.