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Understanding How a Compound Interest Calculator Works
There is no question that compound interest is one of the most powerful investment strategies anyone can use for the purpose of advancing personal financial goals. About half of the fortune amassed by legendary investor Warren Buffett has been achieved through the magic of compounding; we are talking about billions of dollars that he has been able to exponentially grow through reinvestment of interest earned and disciplined income contributions.
Use of a continuous compound interest calculator is among the various benefits of this strategy is the fact that it allows you to visualize investment horizons. You can find many of these calculators online; plus, you can also program a daily compound interest calculator Excel formula for offline use.
The Principle of Compound Interest
In the world of personal finance, interest is an amount paid over a previously established amount, and it is invariably expressed as a percentage that we call interest rate. When you shop around for credit cards, you pay attention to the annual percentage rate (APR) because you do not want to pay too much above your credit purchases or cash advances. When selecting a savings account that can help you achieve compound interest financial goals, you will be looking for banks that offer higher annual percentage yield (APY), which means that they pay more above your account balance.
Not all banks offer compound interest accounts; many instead offer simple interest accounts that do not reinvest the interest that has already accumulated, thus reducing the exponential factor when compared to compounding accounts. This contrast between simple and compound interest cannot be stressed enough. You always want to look for personal finance interests that pay compound interest even when the APY is lower than their simple interest counterparts.
Compound Interest Calculator Formula
You don’t have to be a numbers wizard to understand the basic daily compound interest formula. In essence, this is a mathematical constant that can be expressed as a logarithm, which means that there is an exponentiation property at play. Let’s look at the factors within the compound interest formula:
P * (1 + R / N) ^ (N * T)
* P stands for the principal amount, which is your initial deposit.
* R is the interest rate, which financial institutions mostly express as APR.
* N is the frequency at which reinvestment will take place as stated in the terms of the account prospectus. You would preferably look for daily or weekly compounding because these are more dynamic frequencies.
* T is the length of time the investment will unfold. As Warren Buffett has previously commented, longer will always be better.
As you can see in the formula above, there is no algebra involved, and the arithmetic operands are sum, fractions, multiplication, and exponentiation. You can figure this out on a calculator, but you would be leaving out the contribution factor, which happens to be the most powerful aspect of a compounding strategy; we will discuss this a little later.
If you are using Microsoft Excel, you can use the Future Value (FV) function to figure out compound interest scenarios. Let’s take a look at the FV variables:
FV(rate, nper, pmt, [pv], [type])
The rate is self-explanatory. The nper variable is the length or number of periods. The pmt variable is how much is being paid. The pv variable, which is optional, is the amount of the initial deposit, and the type refers to whether the payment is made at the end of the period, which is what most banks do, thus giving this variable a value of 1.
Online Compound Interest Calculators
Most of the online compounding calculators you find online will offer all the factors and variables described above in addition to contributions, which are vital to the success of your investment strategy. The more money you can deposit on a frequent and constant basis, the better your investment horizon will look.
When you work with an online weekly compound interest calculator, you will have a chance to play around with the contribution variable, and you will be able to visualize how much more your account balance can grow if you increase your weekly deposits. The results you get from a daily interest calculator will only be different from compound interest calculator quarterly results in the periodic sense. In the spirit of being more competitive, more banks are offering daily compounding, so this is the variable you are more likely to be applying.
Finally, the contribution variable is the one that will make the difference. Any disposable income you can deposit in your compound interest account will help you reach your financial goals faster, and you will be able to exceed your goals if you increase your contributions.