Compound interest is an interest rate on a loan, investment, or other financial transaction that is counted more than once during the year. Compounding interest very often can result in higher interest payments, so you should realize what the future value of the transaction will be, considering the effect of the compound rate on the initial amount. You can learn how to calculate compound interest using the formula explained in the article below.
Steps
Part 1 of 3: Preparation
Step 1. Find the financial documents that establish the compound interest rate for a certain investment or loan
Step 2. Find the numbers you need
You will need to know the amount of money initially invested, the interest rate, the composition of the interest, and the number of years over which the interest will accrue, to determine the final value of the compound interest rate.
Step 3. Get a pen, paper and calculator
These will be useful for entering your data into the formula.
Make sure you use a calculator that can calculate powers
Part 2 of 3: Examine the Formula
Step 1. Look at the formula you will use before entering the numbers
Quantity / Future Value = Initial Investment x (1+ interest rate / compounding frequency per year) ^ (years x compounding frequency per year)
- The number of times of composition per year is an exponent of (1+ interest rate / frequency of composition of the year).
- You can also write "FV = P (1 + 1 / C) ^ (n x c)."
Step 2. Determine the number of times the interest rate is compounded annually
If it is composed daily, it will be 365, if it is composed weekly, it will be 52, and if it is composed monthly it will be 12.
Part 3 of 3: Using the Formula
Step 1. Enter the numbers you are using in the formula
- For example, if you want to invest $ 5000 with an interest rate of 3.45%, compounding the interest monthly for two years, you would write FV = 5000 (1 + 0, 0345/12) ^ (12 × 2).
- Convert the interest rate to decimal before inserting it into the formula. Divide percent to get decimals.
Step 2. Simplify the problem by solving the parts of the equation in parentheses
For example, FV = 5000 (1 + 0, 0345/12) ^ (12 × 2) can be simplified to FV = 5000 (1, 002875) ^ (24)
Step 3. Simplify further by solving the exponent of the last part of the equation before multiplying by the original amount
For example, (1, 002875) at the 24th power is 1, 071
Step 4. Solve the equation by multiplying this number by the starting amount
FV, or future value, is the amount of money you will have after two years.
Step 5. For example, FV = 5000 (1, 071) or FV = $ 5355
You will earn $ 355 in interest.
