Are you trying to get the most out of a compound interest calculator, also called a CIC, that you found at an online finance website? If so, there’s good news. Because once you learn the basics of any CIC, you can use any of them.
Some are a bit more sophisticated than others, but they all operate on the same basic principle: they use an app to perform a mathematical formula that lets users see the “future value” of a one-time or repeated amount of savings, based on a given interest rate.
Working With a Compound Interest Calculator
Here’s what you need to know to work with a compound interest calculator. Note that nearly all the online versions of investment calculator ask you simple questions about how much money you open an account with, how frequently you make deposits, what the size of those deposits will be, when they will end, and what the assumed interest rate is.
Hypothetical Example
Here’s an example of how to use a CIC with a hypothetical case. Suppose you’ve got $500 from a bonus check at your job. You want to deposit it into a guaranteed-interest-rate money-market fund that pays four percent interest. Every month, you will be putting $500 into the account, from the second month until five years have passed, or the 60th month.
Remember, the first month, you’re depositing $500 from your bonus. After that, for the next five years, you’re putting $500 per month into the account, and it pays four percent interest.
Let’s do a little bit of simple math. In all, forgetting about the compound interest for a minute, you’ll be making 60 deposits of $500 each. The total comes to $30,000 ($500 x 60). But, wait. What about the four percent interest that is compounded monthly?
In other words, because the institution is paying your annual interest on your balance, they’ll calculate the compounded interest amount at the end of each month. Keep in mind that the four percent rate is *annual*, not monthly. What is the monthly interest rate?
It’s simply four percent divided by 12, or .33 percent, or we could say “one-third of a percent,” which makes more sense. So, the bank pays one-third of a percent interest every month on whatever your balance is. Realize that you’re receiving interest paid not just on the principal balance but also on the interest that has accumulated in the account at any given time.
Using the CIC To Find Out the Final Balance
How can you use a compound interest calculator to figure out the final amount that will have built up after five years? Simple. Just answer the questions the calculator app asks you. Every compound interest calculator begins with a series of queries. You provide the information. In the example we’re working with here, you would answer the CIC’s questions like this:
- “What is the initial amount of the deposit?”
Answer: $500
- “Are the recurring deposits made at the beginning or end of each month or year?”
Answer: At the beginning of each month.
- “What is the interest rate?”
Answer: Four percent.
- “How many deposits will be made?”
Answer: Sixty (once per month for five years)
After that, you’ll see a button that says something like “Calculate the total amount.” Click it and the result will appear. If you put $500 into the account for 60 months and earn four percent interest, compounded monthly, your final balance will be $33,149.49.
Evaluating the Results of the Investment Calculator
Notice that you will have earned $3,149.49 in interest due to the compounding effect. The base amount of your deposits was only $30,000.
There’s an interesting thing that happens with compound interest when you use long periods of time, like 20, 30, or 40 years instead of five years, as we did in the example. The amount of interest grows exponentially. For example, if we had saved our $500 per month for 40 years instead of just five, we would have ended up with $590,980.67, which represents $240,000 of principal and $350,980.67 in interest.