Compound Interest Explained: Formula, Examples, and the Rule of 72
Albert Einstein allegedly called compound interest the "eighth wonder of the world." Whether he said it or not, the math is undeniably powerful. Here's everything you need to understand it.
Simple Interest vs. Compound Interest
Simple Interest
Interest is calculated only on the original principal. Each year earns the same fixed amount.
₹10,000 at 10% for 5 years → ₹5,000 interest
Compound Interest ✨
Interest is earned on both principal AND previously accumulated interest — it snowballs over time.
₹10,000 at 10% for 5 years → ₹6,105 interest
The Compound Interest Formula
Worked Example
Compounding Frequency Matters
The same principal, rate, and duration — but different compounding intervals:
| Frequency | n value | Final Amount (₹1L @ 8%, 10yr) |
|---|---|---|
| Annual | 1 | ₹2,15,892 |
| Semi-annual | 2 | ₹2,19,112 |
| Quarterly | 4 | ₹2,20,804 |
| Monthly | 12 | ₹2,22,039 |
| Daily | 365 | ₹2,22,535 |
More frequent compounding = slightly more interest. The difference between annual and daily is about ₹6,600 over 10 years on ₹1 lakh.
The Rule of 72
The Rule of 72 is a quick mental shortcut to estimate how long it takes to double your money at a given compound interest rate:
Compound Interest in Real Life
Frequently Asked Questions
What is the difference between simple and compound interest?
Simple interest is calculated only on the original principal. Compound interest is calculated on the principal plus all previously accumulated interest — it grows exponentially. For example, ₹10,000 at 10% for 5 years: simple interest gives ₹5,000 total interest, while compound interest (annual) gives ₹6,105.
What is the compound interest formula?
A = P × (1 + r/n)^(n × t), where A is the final amount, P is the principal, r is the annual interest rate (as decimal), n is the number of times interest compounds per year, and t is time in years.
What is the Rule of 72?
The Rule of 72 is a quick mental formula to estimate how long it takes to double your money: Years to double = 72 ÷ Annual Interest Rate. For example, at 8% interest, your money doubles in 72 ÷ 8 = 9 years.
How does compounding frequency affect returns?
More frequent compounding gives slightly higher returns. For ₹1 lakh at 8% for 10 years: annual compounding gives ₹2,15,892, monthly gives ₹2,22,039, and daily gives ₹2,22,535. The difference is modest but grows with higher rates and longer durations.
Is compound interest good or bad?
It depends on which side you are on. Compound interest works FOR you when you invest (FDs, mutual funds, PPF, NPS). It works AGAINST you when you borrow — especially credit cards, which compound monthly at 36–48% annually. Pay off high-interest debt before investing.
Which investments use compound interest in India?
Fixed deposits (quarterly compounding), PPF (annual compounding), NPS, recurring deposits, and most mutual funds use compounding. SIPs benefit from compound growth over long periods. Even savings accounts compound interest, typically quarterly.
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