Simple and compound interest
Without compounding, interest is calculated on the money you put in and paid at the end of the term. With compounding, the interest earned is added to the balance at regular intervals and starts earning interest itself. The more often it is compounded, the higher the result for the same rate.
How it is calculated
- Interest accrues every month at the annual rate / 12 on the current balance.
- With compounding, the accrued interest is added to the balance at the end of each month, quarter or year, and at the end of the term.
- Top-ups are made at the start of every month from the second one on, so each of them earns interest from that month.
- The effective annual rate shows what a year of compounding is worth: (1 + r / m)m − 1, where m is the number of compounding periods per year.
Taxes, fees and early-withdrawal penalties are not included. Banks often accrue interest daily, so their figures may differ slightly.
Example
100,000 at 10% a year for 12 months grows to 110,000.00 without compounding and to 110,471.31 with monthly compounding. The effective annual rate of 10% compounded monthly is 10.47%.