About Compound Interest
Compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. This differs from simple interest, where interest is calculated only on the principal.
Understanding APR vs APY
When comparing financial products, it's important to understand the difference between APR (Annual Percentage Rate) and APY (Annual Percentage Yield):
- APR: The annual rate of interest without taking into account the compounding of interest within that year
- APY: Takes into account the effect of compounding interest, giving you the actual interest you'll earn over a year
Compound Interest Formula
The formula for compound interest is:
A = P(1 + r/n)nt
Where:
- A = Final amount
- P = Principal (initial investment)
- r = Annual interest rate (decimal)
- n = Number of times interest compounds per year
- t = Time in years
Common Compounding Periods
- Daily: Interest compounds every day (n=365)
- Monthly: Interest compounds every month (n=12)
- Quarterly: Interest compounds every three months (n=4)
- Annually: Interest compounds once per year (n=1)
The more frequently interest is compounded, the more interest you'll earn on an investment (or pay on a loan) over time.