Investment varies depending on the sector you are investing, depending on the risk involved with it. Most people are aware of the basic difference between simple and compound interest. Here is a simple example which will help you understand better how you investments are impacted and multiplied with compound interest.
Simple interest is interest paid only on the "principal" where as compound interest is calculated, not only on the principal, but also on the interest that has accrued, or built up, at the time of the calculation.
While depositing in bank fixed deposits the depositor has to clearly indicate to the bank at the time of making the deposit that he would like to take advantage of compound interest rate and ask for a reinvestment deposit scheme.
Let us consider simple example, Deposit amount is Rs 1000 and the interest is 10% for the 3 year deposit.
|Simple Interest(Rs.)||Compound Interest(*)(Rs.)|
|Amount of Deposit||1,000||1,000|
|Amount receivable After One Year||1,100||1,103|
|Amount receivable After Two Years||1,200||1,218|
|Amount receivable After Three Years||1,300||1,344|
|Note: (*)Interest on Interest Earned is added to the principal amount quarterly|
This is the formula FV = PV x (1 +i)N
- where: FV = future value of the investment
- PV = present value of the investment
- i = rate of interest earned each period
- N = number of periods
Excel Calculations One can use Microsoft excel to calculate compound interest. The function used in Excel is
FV (future value). =FV(rate,nper,pmt,pv,type)
- where: rate = the interest rate per period
- nper = the number of payment periods
- pmt = used if an additional payment is made each period (otherwise left blank)
- pv = the present value of the investment
- type (optional) = the number 0 or 1, and is used if additional payments are made whereby 0 = at the end of the period, and 1 = at the beginning of the period.