Principal Amount: The initial amount of money you invest.
Total Interest: The total profit earned on your investment. Unlike simple interest, this amount grows faster each year because you earn "interest on interest".
Total Maturity Value: The final projected value of your investment, including both your principal and the total interest earned.
Effective Annual Rate (EAR): This is your true annual rate of return when compounding occurs more than once a year. For example, a 12% annual rate compounded monthly has an EAR of 12.68%, which is higher than the stated rate.
Often called the "eighth wonder of the world," compound interest is the single most important concept for anyone looking to build long-term wealth. This guide explains why.
Compound interest is the concept of earning interest on your interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest.
"Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." - Often attributed to Albert Einstein
The difference is staggering over time. Let's take an example:
With Simple Interest, you would earn ₹10,000 every year. After 20 years, your total value would be ₹1,00,000 (Principal) + ₹2,00,000 (Interest) = ₹3,00,000.
With Compound Interest (compounded annually), your money grows exponentially. After 20 years, your total value would be approximately ₹6,72,750! That's more than double the return of simple interest, all thanks to the "interest on interest" effect.
The future value of an investment is calculated using the formula:
A = P(1 + r/n)^(nt)
The "Rule of 72" is a quick, useful formula to estimate the number of years required to double your money at a given annual rate of return.
Years to Double ≈ 72 / Interest Rate
For example, if your investment earns 12% per year, it will take approximately 72 / 12 = 6 years for your money to double.