What is compound interest?
With compound interest, the interest you earn is reinvested and starts earning interest of its own. Your balance grows faster and faster over time: this is the “snowball effect”. With simple interest, only the money you put in earns a return.
Example: $10,000 invested at 5% a year becomes $10,500 after one year. In the second year, 5% applies to $10,500, so you earn $525 instead of $500. After 20 years the balance reaches about $26,533, compared with $20,000 using simple interest.
The compound interest formula
For a single deposit, the formula is A = P × (1 + r)n, where P is the principal, r the rate per period and n the number of periods.
With regular contributions C made at the end of each month, you add the future value of an annuity: C × ((1 + r)n − 1) / r, with r the monthly rate. This calculator runs the numbers month by month, which also lets you increase your contributions every year.
Annual or monthly compounding?
With monthly compounding, the annual rate is divided by 12 and interest is added every month, so the effective yearly return is slightly higher than the stated rate (5% compounded monthly is about 5.12% a year). With annual compounding, the calculator uses the equivalent monthly rate so that the return over a full year is exactly the rate you entered. It is the more conservative choice when you know an investment's annual return.
Time is your best friend
How long you invest matters more than how much. Saving $200 a month at 5%, starting ten years earlier can almost double the final balance. Try a few different lengths of time: the share of interest in your final balance rises sharply after 15 to 20 years.
Accounting for inflation
A dollar in 20 years will not buy as much as a dollar today. The “In today's money” figure divides the final balance by cumulative inflation to show its purchasing power at today's prices. To grow your wealth in real terms, your net return needs to beat inflation.
FAQ
What rate of return should I use?
It depends on the investment. Savings accounts pay a modest rate, bonds a little more, and stocks have historically returned more over long periods, with large swings along the way. Try several scenarios, including a cautious one.
Does the calculator include taxes and fees?
No, it shows a gross return. To estimate your net result, enter a rate reduced by management fees and the taxes that apply to your account.
What is the Rule of 72?
A quick way to estimate how long it takes to double your money: divide 72 by the annual rate. At 6%, money doubles in about 12 years; at 3%, in about 24 years.
Is this financial advice?
No. The results are mathematical projections based on a constant rate and do not guarantee future returns. For investment decisions, talk to a licensed financial adviser.