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Difference between compound interest and simple interest

Whenever you deposit or invest your money, you’re entitled to get interest on it. That interest can be compound interest or simple interest.

Every time you got into a financial transaction you have to deal with compound interest and simple interest.

And understanding the difference between compound interest and simple interest can make your money work harder than you.

In this post, I’ll define what is simple and compound interest? Gave some examples to understand them even further. And how to calculate compound interest on a calculator.

What is simple interest?

The simple interest is what you get on your initial investment. It is charged when you give your money to someone for use, thereby you get simple interest.

In a nutshell, it is a cost of borrowed money. Mostly it is in the percentage of your investment.

For example, Suppose you invest Rs 1 lakh in an FD(fixed deposit) with the rate of 6 % annually. After one year you’ll get Rs 6,000 on your investment.

Rs 6,000 interest you earned each period on the Rs 1 lakh original investment is known as simple interest.

What is compound interest?

Unlike simple interest, in which you’re entitled to get interest only on your initial investment, compound interest earned interest on interest.

Although the simple interest on your initial investment is fixed.

The compounded interest earned on reinvested interest is far more powerful because, as your time horizon increases your investment gains also maximizes.

For example, Rs 1 lakh invested today would be worth about 14,69,77,156.80 after 40 years if compounded annually at 20 percent.

Difference between compound interest and simple interest

  Simple interest compound interest
Meaning

The simple interest is what you get on your principal.

The compound interest earned interest on interest and also the principal.
Formula
A = P (1 + rt)
A = final amount
P = initial principal balance
r = annual interest rate
t = time (in years)
A = P(1 + \frac{r}{n})^{nt}
A = amount
P = principal
r = rate of interest
n = number of times interest is compounded per year
t = time (in years)
Growth Steady growth Exponential growth due to compounding
Returns Lower returns Higher returns
Interest charged On principal only On both principal and interest
Used in Bonds, FD, car loans, etc… Stocks, saving accounts, etc…

How to calculate compound interest on a calculator?

Suppose we want to calculate returns on the stock, Rs 1 lakh if compounded annually at the rate of 10% then how much is it worth after 10 years?

This is our compound interest formula: A = P(1 + r)^n (we didn’t use nt here because it is compounded annually)

A= 100,000(1+0.1)^10

how to calculate compound interest on a calculator

First, calculate (1+0.1)^10. 

in the bracket, you’ll get 1.1, then click the above symbol shown in the image and type the number of years compounded.

And you’ll get 2.5937424601. Now multiply 2.59374246019(this) to the principal amount that is 100,000.

The answer is 259,274.24602.

That’s How you can calculate compound interest on a calculator.

If you don’t want to calculate on a calculator, just go to this website where calculations would be easy for you.

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