Compound interest is what happens when interest starts earning interest. On simple interest you earn a flat rate on your original amount every year. On compound interest each year's interest is added to the balance, and the next year is calculated on that larger figure. The gap between the two widens every single year, and by year fifteen it stops being a small difference.
Why compounding needs time to matter
Take Rs 1,00,000 at 7% for 15 years. With simple interest you end with roughly Rs 2,05,000. With compounding you end with about Rs 2,84,900. The extra Rs 79,900 was not a higher interest rate; it was interest that your earlier interest had earned. In year one, compounding and simple interest are identical. By year fifteen, close to a third of the balance is earnings rather than deposits.
This is the arithmetic behind the standard advice about starting early. Someone starting at 25 for 40 years ends up with a far larger sum than someone starting at 35 for 30 years, even with identical monthly amounts, purely because the first investor's money spends more years compounding.
How the calculation works
- Your starting amount is grown for the full number of years.
- Each monthly addition is treated as a separate deposit, grown for the months remaining after it was made.
- The monthly rate is the annual rate divided by twelve. Annual compounding is the same idea applied in fewer, larger steps.
Most Indian bank deposits and bonds pay annually, so the difference between monthly and annual compounding is small over short periods. Across thirty years it becomes noticeable, which is why recurring deposit calculators and most fund calculators use monthly compounding.
Where compound interest works for you
- Fixed deposits and recurring deposits, where the bank credits interest into the principal.
- Equity mutual funds and SIPs, over a horizon long enough to ride out bad years.
- PPF and EPF balances, which compound annually for decades without any action from you.
- Debt funds, at a lower rate but with far less volatility than equity.
Where it works against you
The same maths runs in reverse on credit card balances and consumer loans, usually at a punishing rate. A credit card at 36% annual interest compounded monthly roughly doubles a balance in two years. This is why clearing high-interest debt beats investing into a lower-yielding product when you cannot do both, and it is worth running both numbers here before deciding.
Choosing a realistic rate
Use a rate that matches the actual product. A savings account might pay 3-4%, a bank FD 6-7%, a corporate bond fund 8-9%, and an equity fund 12-13% over a long period. Do not use the equity rate to justify holding cash, and do not use the savings rate to describe a market-linked investment. A projection built on the wrong rate is worse than no projection at all.
Frequently asked questions
What is compound interest?
Compound interest is interest calculated on the original amount plus the interest already earned. Each period the balance grows, and the next period applies the rate to that larger balance, so growth accelerates over time.
How is compound interest different from simple interest?
Simple interest applies the rate only to the original principal, so the yearly interest never changes. Compound interest applies the rate to the growing balance, so the yearly interest increases. Over long periods the difference becomes very large.
How often is interest compounded in India?
Bank FDs and most bonds compound annually. Equity and debt mutual funds compound daily through the NAV and are usually discussed as a monthly or annual return. Credit cards and most retail loans compound monthly.
Does the calculator include taxes?
No. The figure shown is the balance before any tax on interest or gains. Interest on a bank FD is fully taxable under your income slab, and fund gains follow their own rules that depend on the holding period.