Compound interest is one of the most important concepts to understand in investing. Itâs something about investing that many people arenât familiar with, but it plays an essential role in making investments profitable.Â
If youâre curious about compound interest and how it works, good for you â youâre on the right track. In this post, youâll find a compound interest calculator that can quickly and clearly show you how much money you might make by investing in an account that delivers compound interest.Â
Use the calculator below to get a sense of your potential earnings, then read the sections below to gain more insight into how you can make money through compound interest.Â
- How to use a compound interest calculator
- Investment definitions
- How does compound interest work
- Compound interest formula
- Compound interest accounts
- Compound interest FAQs
How to use a compound interest calculator
Using the compound interest calculator is simple. Follow these steps to see what you might earn through compound interest investing.Â
- Enter your initial investment. It can be any value that you like, but itâs helpful to make it a realistic amount. For instance, if youâre saving up to invest right now, you can put the amount that you plan on investing once youâve saved up enough.Â
- Next, enter the amount you plan on adding to your investment portfolio each month. This can also be any value you like, but itâs most useful if you enter an amount that you can budget for. Even if thatâs just an extra $10 a month, it makes a difference.Â
- Choose whether you want your interest compounded annually, compounded monthly, or compounded daily. (If you donât know what that means, stay tuned for the definitions below.)Â
- Input the estimated rate of return. This can vary considerably, but index funds and similar investment vehicles can yield between 2% and 10% returns.Â
- Input your time horizon â the amount of time until you withdraw or use your investments.Â
Once youâve filled out the calculator, you should see an estimate of the amount youâre likely to have when the period of compound investing is up. If youâre a little confused about how we got this number, or what you need to do to grow your money in this way, check out the definitions, guide, and FAQs below.Â
- Compounding: This occurs when the money that is made from an investment is reinvested, increasing the total amount of interest yielded the next time your interest is compounded.Â
- Index fund: Index funds are bundled investments that roughly track the growth of a market index, which is a collection of publicly-traded companies. They are often considered lower-risk investments.
- Interest: The money you make on your investments; essentially, the money you earn for investing in the success of a company, a government bond, or a fund.
- Principal: The amount of money that you start out with when you begin investing.
- Rate of returns: The rate at which you accrue interest â for example, 3% returns would mean that, for every $100 invested, you would earn $3.Â
- Returns: The money that you earn on your investments.Â
- Time horizon: The amount of time that you plan on investing.
Now that you have a few key compound interest definitions in mind, we can explain how it works.Â
How does compound interest work
Having more money can help make you more money â thatâs the principle behind compound interest. Hereâs how that breaks down. Letâs say that you have $1000 to invest. You put it in an account (letâs say a money market account) that yields 2% interest, compounded monthly. At the end of the first month, youâd have $1020. So far, so good.
But hereâs where it gets really interesting. That 2% rate of return now applies to the $1020 total, not just the principal investment of $1000. So, after the end of month 2, youâll have $1040.40 â an added $0.40 compared to the previous month.Â
That might not sound like a lot, but it starts to add up. Have you ever rolled a snowball down a hill? The same idea applies. As your money grows and adds to itself, the amount that it can add to itself the next time your interest compounds is more. It may not be a get-rich-quick scheme, but itâs a reasonably secure way to start building your net worth in the long term.Â
Plus, youâre not limited to money market accounts with rates as low as 2%. If youâre willing to put a little more risk on the line, you can get returns as high as 10% in some cases. Weâll cover that more in a later section. But first, time for a little math homework (just for those who are curious!).Â
- Looking for a longer explanation? Check out our full-length guide to how to earn compound interest.Â
Compound interest formula
Compound interest is really mathematically interesting. Hereâs the formula: A = P(1 + r/n)(nt)
If you want to try to see whatâs going on behind the scenes in our calculator, hereâs how to do the math yourself using the compound interest formula.Â
- The A in the formula is the amount youâll end up with; this comes last.Â
- The P in the formula above stands for your principal, thatâs the amount that you start with.Â
- Multiply P by 1 + your interest rate r (given in a decimal; so 4% would be 0.04) divided by n, the number of times your interest is compounded in a given period.Â
- Raise all of that to the power of n times t, where t is the number of time periods elapsed.Â
- For example, if youâre investing for 12 months, and your account interest is compounded daily, n would be roughly 30, and t would be 12 if you want to know how much youâll have in a year.Â
Try the formula out yourself, and see what result you get compared to the result in our calculator to check your work!
Compound interest accounts
Now that you understand the basics of compound interest, youâre probably wondering how you harness it to increase your net worth. The key is to use accounts that offer compound interest. Here are a few examples:
- High yield savings and money markets. These are essentially savings accounts. They arenât investment accounts (which weâll discuss in a minute), but they do use a similar principle to grow your money. Rates on these can be fairly low compared to other options, but your money remains accessible, so you wonât have to worry if you need access to your cash fast in an emergency.
- Retirement accounts. If you have a 401k or IRA opened right now, good news: youâre already accessing the power of compound interest. Most retirement accounts use a diversified and stable portfolio to grow your money over time, investing in index funds, government bonds, and dividend stocks to help you build your nest egg.Â
- Investments. Of course, one of the most aggressive and effective ways to utilize the power of compound interest is to start investing. There are a number of different ways you can invest â be sure to read our guide to investing for beginners for a more thorough explanation â but all can involve compound interest. For example:
- Dividend stocks sometimes allow you to reinvest the payout from your dividends, increasing the amount of your dividend the next time there is a payout.Â
- Index funds, like mutual funds and ETFs, also often allow investors to reinvest their earnings, harnessing compound interest in their favor.Â
- If you invest directly in stocks, you can always use the money that you earn to reinvest or invest in another stock â be aware that this is a riskier option, however.Â
- Whether you choose an in-person brokerage or a trendy new robo-advisor, youâll likely be able to use the power of compound interest to grow your capital.Â
Compound interest is a mathematical force that can help you build your net worth over time. You can get started today by finding the right investing or saving vehicle for your personal finances. And donât forget to download the Mint app, where you can conveniently track your investments all in one place.Â
Compound interest FAQs
How do I calculate compound interest?
You can calculate compound interest in one of two ways: you can use the formula listed above to calculate it by hand, or you can use the compound interest calculator to figure out your total more quickly. Just be sure you know the necessary variables:
- The principal amount
- Your interest rate
- How often itâs compounded
- The number of compounding period that will occur
What will $10,000 be worth in 20 years?
That totally depends on how much interest your account produces and whether you invest more as time goes on.Â
Letâs assume an average return rate of around 7%, and assume that you donât add in any more money. In that case, your $10,000 could turn into $40,547 â still an impressive amount. Thatâs the power of compound interest.Â
How do you calculate compound interest monthly?
To calculate compound interest monthly, simply set the âcompounding frequencyâ setting on the calculator above to âmonthly.â Alternatively, you can use the formula above and set n equal to 1 and t equal to 12 to find out how much money youâll have if interest is compounded monthly for a year.Â
Wealthsimple | Investor.gov
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