What is Compound Interest?
Compound interest is interest calculated on two things:
- a principal amount
- any accumulated interest
How to Calculate Compound Interest
Using the compound interest concept, we can calculate what a principal amount P turns into using the following equation:
Where:
- A: future amount
- P: principal amount
- r: annual interest rate
- n: number of compounding periods
- t: number of years
The compound interest generated is the difference between the future amount and the principal amount.
Example 1
If $2,000 are invested at 8% compounded quarterly, the future amount at the end of 5 years will be:
The compound interest generated is $2,971.89 – $2,000 = $971.89.
Example 2
If $100,000 are invested in the S&P 500 for 35 years, and the average annual compounded return is 9%, the future amount will be:
The compound interest generated is $2,041.396.79 – $100,000 = 1,941,396.79.