The Mechanics of Compound Interest
When using tools like our SIP Calculator or PPF Calculator, the results can often seem disproportionately large over a 20-year horizon. This is not an error—it is the direct mathematical result of compound interest.
What is Compounding?
Simple interest only pays you returns on your original principal. Compound interest pays you returns on your principal and on the accumulated interest from previous periods.
The Formula
The standard formula for compound interest is:
A = P(1 + r/n)^(nt)
- A = Final amount
- P = Principal amount
- r = Annual interest rate (in decimal)
- n = Number of times interest is compounded per year
- t = Number of years
The Importance of 'n' (Compounding Frequency)
A bank offering 7% compounded yearly will yield slightly less than a bank offering 7% compounded quarterly. The more frequently your returns are reinvested (n), the steeper the exponential curve becomes.
Worked Example: ₹1,00,000 invested at 8% for 10 years.
- Compounded Annually (n=1):
100000 * (1 + 0.08)^10= ₹2,15,892.50- Compounded Quarterly (n=4):
100000 * (1 + 0.08/4)^(4*10)= ₹2,20,803.97
Time is the Heaviest Variable
Because time t is the exponent in the formula, doubling the duration of your investment more than doubles your returns. Starting a SIP at age 25 versus age 35 drastically alters the final maturity value, even if the total capital invested is identical.