A crucial first step that most experienced investors take before investing their capital in any investment scheme is calculating the Return on Investment (ROI) of the investment scheme over a specific tenure. The most efficient way of doing the same is calculating the compound interest that the investment shall incur over the tenure. A compound interest calculator is an online tool that helps investors do the same, thereby helping them plan for their investments and earn higher returns by the end of their investment tenure. Read on to learn more about compounding and how a compound interest calculator helps calculating the same.
What is compounding interest?
Compounding interest is a method of calculating interest on interest. It involves adding the interest earned back to the principal amount, so that interest can be earned on interest in subsequent periods.
Compound interest in calculated based on the equation – C = P(1 + r/n)^nt
Where,
| P | Principal Amount |
| C | Compound Interest |
| r | Interest rate |
| n | The number of times the interest compounds in twelve months (a year) |
| t | Number of years |
For example, an amount of Rs. 50,000 is invested in a fixed deposit with 10% annual interest. In the first year, interest of Rs. 5,000 is earned. In the second year, the Rs. 5,000 interest is added back to the principal amount making it Rs. 55,000. Now 10% interest is calculated on Rs. 55,000 which is Rs. 5,500. So, the interest keeps compounding as both principal and interest earn additional interest over time.
What are the advantages of using a compound interest calculator?
While choosing from top mutual funds, investors can use a compound interest calculator to estimate their overall returns more accurately. A compound interest calculator can help investors achieve their investment objectives by helping them chart out an investment plan.
Why use compound interest calculators for mutual fund investments?
A compound interest calculator gives you the ability to forecast long-term returns from mutual funds more accurately. Mutual fund returns compound over long periods as the earned interest or dividends get reinvested. A simple interest calculation cannot capture this effect correctly. But a compound interest calculator takes into account the reinvestment and shows the difference it makes over 5-, 10- or 20-year periods. For example, a mutual fund returning 12% annually will double your money in 6 years if compounded annually. But it will take nearly 9 years if calculated as simple interest. Compounding really accelerates wealth accumulation in the long run. So the compound interest calculator helps you get a more realistic estimate of what to expect from your mutual fund investments over the long term.
Using a compound interest calculator to estimate the returns on any investment is a very beneficial move for any investor. Investors can plan their mutual fund investments in advance, assess whether they wish to remain invested in the scheme, and tweak their investments as and when needed.