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How to Calculate Compound Interest on Investments

By SamK on September 11, 2023
Topic(s)

Compound interest is the interest which is earned both on the original investment (the principal amount) and the total interest accumulated so far. Here are a few methods to calculate compound interest.

Method 1

This method is suitable for interests which are compounding annually or whose duration is just a few years. Suppose the annual compound interest rate is 7% (0.07) on a $1000 investment for 3 years. Then

Interest for first year: $1000 x 0.07 = $70, Total amount: $1070

Interest for second year: $1070 x 0.07 = $74.9, Total amount: $1144.9

Interest for third year: $1144.9 x 0.07 = $80.14, Total amount: $1225.04

So the total amount of interest will be: $70 + $74.9 + $80.14 = $225.04

Method 2

Suppose an interest is compounding more frequently like quarterly, monthly or weekly or spread over a duration of many years, it is more convenient to use the compound interest calculation formula:

FV = P (1 + i/c)n*c

where

FV = Future value of the principal

P: Principal amount

i: Interest rate

c: Compounding frequency per year

n: Number of years

Suppose the interest rate is 5% (0.05) compounding quarterly on a $1000 debt taken for 5 years, then

P=$1000, i=0.05, c=4, n=5

FV = P (1 + i/c)n*c = $1000 x (1 + 0.05/4)5*4 = $1000 x (1.0125)20 = $1000 x 1.282 = $1282

The future value will be $1282 after 5 years.

The compound interest will be $1282 - $1000 = $282