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Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, "interest on interest". It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest.
"Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it."
The standard compound interest formula is:
A = P x (1 + r / n) ^ (n x t)
Where:
Total interest earned is:
Compound Interest = A - P
The more frequently interest is compounded, the faster your money grows. Monthly compounding will produce a slightly higher maturity amount than annual compounding at the same stated rate.
Compounding rewards time. In the early years, most of the growth comes from your own contributions. Over long periods, the interest itself starts contributing a larger share of the final corpus.
This is why starting early can matter more than investing a very large amount later. A 25-year-old investing for 30 years often needs a much smaller monthly amount than a 40-year-old trying to reach the same goal in 15 years.
| Feature | Compound Interest | Simple Interest |
|---|---|---|
| Interest earned on | Principal plus accumulated interest | Principal only |
| Growth pattern | Accelerating | Linear |
| Best example | FD, PPF, mutual fund compounding | Some loans or short-term interest calculations |
| Long-term impact | Higher | Lower |
Compounding appears in many financial products:
Debt also compounds. Credit card dues and high-interest loans can grow quickly if unpaid, which is why compounding can either help or hurt depending on which side of the equation you are on.
Compound interest means earning interest on both your original money and the interest already earned.
Tenure gives previous interest more time to earn additional interest. This is why the final few years of a long investment can contribute a large share of the total corpus.
Yes, if the stated interest rate is the same, more frequent compounding gives a higher final amount.
FDs, PPF, EPF, and long-term mutual fund investments all benefit from compounding in different ways.
Start early, invest regularly, avoid unnecessary withdrawals, and stay invested for longer periods.
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