Last updated on September 18, 2023
What you'll learn:
➤ How to use the compound interest calculator
Experiment with varying scenarios, incorporating or excluding a monthly contribution—ranging from $5 to $200—based on your financial capacity. In addition to a sample rate of return, this savings calculator encompasses an estimation of your annual percentage yield.
To ascertain the projected yield, consider comparing rates across numerous savings accounts and certificates of deposit available.
| Formula | Description |
|---|---|
| A = P(1 + r/n)^(nt) | 💰 Compound interest calculation formula |
| A | 💸 Ending amount |
| P | 🏦 Original balance (principal) |
| r | 📈 Interest rate (as a decimal) |
| n | ⏰ Number of compounding periods |
| t | 🕒 Duration of time |
Compound Interest Formula: A = P(1 + r/n)^(nt)
For example, let’s say you deposit $5,000 in a savings account that offers a 3% annual interest rate, compounded monthly. To find out your ending balance after a year:
- P = Initial deposit = $5,000
- r = Interest rate (as a decimal) = 0.03
- n = Compounding frequency per year (monthly compounding means n = 12)
- t = Time in years = 1
Plug these values into the formula: A = $5,000(1 + 0.03/12)^(12 x 1)
Calculate the exponent first: 12 x 1 = 12 Then the part inside the parentheses: 1 + 0.03/12 = 1.0025 Finally, the entire formula: A = $5,000 * (1.0025)^12 ≈ $5,152
So, after one year, your ending balance would be approximately $5,152 in savings. This demonstrates the power of compounding in growing your money over time.
➤ What is compound interest?
Compound interest is a fundamental concept for savers, defined as the interest you earn not only on your initial deposit but also on the accumulated interest. This mechanism accelerates the growth of your savings over time.
In accounts that utilize compound interest, like standard savings accounts, the returns are combined with the original principal at the end of each compounding period—usually daily or monthly. This cumulative process results in an expanding account balance.
Leveraging the compound interest formula, the account generates even more interest during the subsequent compounding period.
For instance, envision depositing $10,000 into a savings account offering a 4% annual yield, compounded on a daily basis. In the first year, your interest would amount to $408.
Over the second year, it would be $425, escalating to an additional $442 in the third year, and so on. After a decade of compounding, your total interest earnings would accumulate to $4,918.
However, it’s vital to recognize that this is just an illustrative scenario. For long-term savings, there are more advantageous options beyond savings accounts, such as Roth or traditional IRAs, as well as CDs, to effectively allocate your funds.
➤ How compound interest works on investments
When engaging in stock market investments, your gains aren’t determined by a fixed interest rate; rather, they reflect the fluctuation in your investment’s value. As your investment’s value appreciates, you accrue a return.
Should you retain both your initial sum and the returns generated within the market, these earnings undergo compounding over time, paralleling the compounding nature of interest.
For instance, if you allocated $10,000 into a mutual fund and the fund garnered a 6% return in a year, you would gain $600, elevating your investment to $10,600. If the subsequent year also yielded an average return of 6%, your investment would then rise to $11,236.
Over the years, the cumulative effect can be substantial. Imagine retaining that sum within a retirement account for 30 years, continually achieving that 6% average return. Your initial $10,000 would metamorphose into a staggering $57,000.
It’s important to acknowledge that investment returns fluctuate, ranging from yearly to even daily variations. In the short term, riskier ventures such as stocks or stock mutual funds might encounter depreciation.
Yet, across an extended time frame, historical data demonstrates that a diversified growth portfolio typically garners an average annual return of 6%. These returns are generally expressed as an annual rate.
Compound interest holds the potential to actualize your prolonged savings and investment aspirations, particularly if you afford it ample time to work its transformative effect over numerous years or decades. The outcome often surpasses the initial investment by a substantial margin.
➤ Boost your returns with additional contributions
While compound interest holds remarkable potential, the advancement of savings objectives hinges significantly on consistent contributions.
Revisiting the prior savings account illustration and employing the daily compound interest calculator reveals the transformative effect of regular deposits.
Starting with $10,000 and accruing $4,918 in interest over a decade with a 4% annual yield, the addition of $100 monthly deposits would culminate in a substantial $29,648 value after a decade of daily compounding.
This amount signifies an interest of $7,648 on an aggregate deposit of $22,000.
