Glossary
Compound interest
Interest earned on previously earned interest — the engine behind long-term wealth.
Definition
Compound interest is interest calculated on both the original principal and on accumulated interest from earlier periods. Unlike simple interest, the base grows each period, which makes the curve steepen sharply over long horizons. Compounding is the engine behind mutual-fund SIP growth, fixed-deposit maturity values, and the cost of long-tenure loans.
Formula
A = P × (1 + r/n)^(n·t)
A = final amount, P = principal, r = annual rate (decimal), n = compounding periods per year, t = years.
Key points
- The longer the horizon, the larger the compounding effect — early years contribute disproportionately.
- A 1 % difference in rate over 20+ years can change the final corpus by 20–30 %.
- Compounding cuts both ways: it grows investments and grows loan balances if interest accrues.
- Daily / monthly compounding gives a slightly higher effective rate than annual compounding at the same nominal rate.
Worked example
₹1 lakh invested at 10 % for 20 years compounds to roughly ₹6.7 lakh — a 6.7× multiplier from compounding alone, no additional contributions. The same investment at 10 % simple interest would reach only ₹3 lakh. The gap (₹3.7 lakh) is pure compound effect — interest stacking on interest.
Related
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