FinanceGuide5 parts · 1 min
How compound interest grows a balance
Apply the yearly rate as often as it compounds, and raise that growth to the number of periods.
The answer
Divide the annual rate by the number of compounds in a year, add 1, and raise that to compounds times years. Multiply by the starting amount. Monthly compounding uses 12.
One amount, no extra deposits
Start with the amount already saved. The formula does not add a monthly contribution. If you put in more money later, that is a new calculation, not a hidden term in this one. Nothing is withdrawn either.
A 5% annual rate compounded monthly is 5 ÷ 12 percent each month, for 12 × years months. On $1,000 for two years that is about $1,104.94. The same rate compounded once a year is $1,000 × 1.05 × 1.05 = $1,102.50. The gap is the compounding, not a different rate.
This is not a loan payment
A loan payment uses the rate to pay a balance down to zero. Compound interest here lets a balance grow. Using one result as the other will not match a lender or a bank statement. Fees and a variable rate are outside the formula.
Examples
$1,000 at 5% for 2 years, monthly
About $1,104.94, of which about $104.94 is interest.
Common mistakes
- Dividing a 5% rate by 100 twice.
- Treating a loan payment as the future value of a deposit.
Questions
What number do I enter for monthly compounding?
12 compounds per year. Quarterly is 4. Once a year is 1.