Reviewed by Aug 26, 2020| Updated on
When one generates earnings from their previous earnings, it is known as compounding. The ability of an asset to generate earnings, which are then reinvested to generate its own earnings is called a compound. The earnings are also known as"compound interest”.
Understanding Compound Interest
The formula to calculate compound interest is:
Compound Interest = Total amount of Principal and Future Value of Interest less Principal amount at present = [P (1 + i)n] – P = P [(1 + i)n – 1] (Where P = Principal, i = nominal annual interest rate in percentage, and n = number of compounding periods.)
While computing compounding interest, the number of compounding periods is very significant, as the higher compounding periods are, the greater is the compounding interest.
One must adjust 'i' and 'n' accordingly if the number of compounding periods is more than once in a year.
The ‘i’ must be divided by the number of compounding periods per year, and ‘n’ is the number of times the loan or deposit matures in a year.
Albert Einstein said that the power of compounding was said to be deemed the eighth wonder of the world or so the story goes.