Compound interest is the eighth wonder of the world, as famously quoted by Albert Einstein. This is because compound interest allows you to earn interest on the interest you've already earned. It's like a snowball effect, where your investment grows larger and larger over time. In India, compound interest plays a significant role in many investment options, such as fixed deposits, mutual funds, and recurring deposits. 

Compound interest is a form of interest that is calculated using the original amount of money invested or saved, as well as the interest that has accumulated in previous periods. Essentially, compound interest is "interest earned on the interest earned." This type of interest enables investments or savings to grow faster than simple interest, which is only calculated based on the principal amount.

It is important that you understand how an interest calculator works for you to know how much you’ve saved and how much you’ve accumulated interest for the amount saved over the years. 

Compound interest formula: A = P(1+r/n)^nt. 

Here's a simple breakdown of the formula for your easier understanding.

A = the future value of the investment

P = the principal balance

r = the annual interest rate (decimal)

n = number of times interest is compounded per year

t = the time in years

^ = ... to the power of …

By multiplying the initial balance by one plus your annual interest rate raised to the power of.time periods (years) you will arrive at your annual compounding rate. Together this provides you with a combined figure for both your principal and compound interest.

When you add regular deposits to your savings or investment accounts, like SIP, 401(k) or Roth IRA, along with the power of compounding interest, it makes a smart way for you to make your money grow faster in the long run.

Let’s say, for example -You are starting to invest an extra Rs. 5,000 every month, your total after 20 years could grow to a substantial Rs. 45,00,000. You'd be earning close to Rs. 22,00,000 in interest on your total contributions i.e is Rs. 23,00,000.

Experts often emphasize that if you start investing regularly at a young age, your savings can grow significantly which will help you lead a comfortable life during your later days. Over time, your interest will accumulate, and you'll benefit from strategies like Rupee-cost averaging, helping your money grow even more.

Using a compound interest calculator in India is simple. All you need to do is enter your initial investment, the interest rate, the frequency of compounding, and the number of years you plan to invest. The calculator will then show you the amount you will earn over time, including the interest earned on the principal and the interest earned on the interest.

Compound interest is an incredibly useful tool that can help you grow your wealth exponentially. Unlike simple interest, which only accrues interest on the initial investment amount, compound interest includes interest earned on both the principal amount and any accumulated interest. But with so many factors to consider, it can be difficult to calculate the total interest you will earn over time. That's where a compound interest calculator comes in handy.

A compound interest calculator is essential in India because it helps you make informed investment decisions. With a compound interest calculator, you can compare different investment options and choose the one that will give you the best returns over time. You can also use the calculator to see how much you will earn if you invest a certain amount for a specific period.

There are several benefits of using a compound interest calculator in India. Here are some benefits.

For instance, if you invest Rs. 50,000 with an annual interest rate of 10% for 5 years, the returns for the first year will be:

Rs. 5,500 (50,000 x 10/100 = 5,000, plus the principal amount of 50,000 = 55,000)

For the second year, the interest will be calculated on Rs. 55,000, resulting in returns of:

Rs. 6,050 (55,000 x 10/100 = 5,500, plus the previous year's returns of 5,000 = 10,500, plus the principal amount of 50,000 = 60,500).

The amount will continue to increase each year after that, with interest being calculated on the principal amount plus the returns from the previous year. Calculating these amounts manually can be challenging, so using a compound interest calculator is so helpful.

Over time, the impact of compounding becomes more significant. The interest or returns from previous periods get added to the principal, increasing the total principal amount. This, in turn, leads to earning interest on a higher principal.

A general rule of thumb is that the longer you allow your principal to grow, the larger your accumulated amount will be, leading to increased interest earnings. For example, consider our earlier illustration. We divided 5% by 4 because interest compounds quarterly, effectively compounding 20 times in 5 years. Although the actual investment period is 5 years with a 5% rate, the formula treats it as 20 time periods with a rate of 1.25% (5% ÷ 4).

This effectively boosts your annual interest rate. If you receive compound interest at 1.25% per quarter on ₹100 instead of 5% per annum, you'd have ₹105.0945 at the year's end (instead of ₹105 with a 5% annual rate). The impact is more noticeable with larger sums and longer investment durations, highlighting the power of compounding.

For instance, imagine you've invested ₹1 lakh in a fixed deposit earning 10% per annum, compounded quarterly. Since it compounds quarterly, the effective interest rate is slightly higher at 10.381%.

Here's a comparison of the effective rates over the years when we contrast annual compounding with quarterly compounding:

While the power of compounding is truly remarkable, you must understand that even when you are earning interest due to compounding benefits it may work sometimes against you when you are paying for it. To make full use of the power of compounding and harness it, you can invest in various assets like mutual funds, fixed deposits or the PPF. 

Let’s see how it works its magic in the long term so that you reap the benefits of compounding interest with a clear cut example. Let’s say you are investing 1,00,000/- per year in an equity mutual fund. Assuming it generates a 10% annual return, here’s how your investment may pan out and grow over different time frames:

With this you can see how your investment triples in justs 20 years, all because of the power of compounding. 

Disclaimer: The content on this page is generic and shared only for informational and explanatory purposes. It is based on industry experience and several secondary sources on the internet, and is subject to changes.