Compounding can be your best friend or your worst enemy, depending on which side of the lending you are on. If you are saving up for a big goal, such as a vacation or to pay for college expenses, compounding can help you reach your goals faster. When you borrow money, such as when you use your credit cards, compounding can cost you money. Let’s explore compound interest and how to use a compound daily interest calculator to see how it adds up over time.
Interest on Savings vs. Interest on Loans
Usually, when you put money into a savings account, the bank compounds the money quarterly. This means that you will earn on your principal plus the interest only four times a year, but the story is different when you borrow money. If you take out a loan or use your credit cards, the bank will compound the interest that you pay daily. Many cards have a grace period of up to 60 days, where you will not pay interest, but if you still carry the balance past the 60-day mark, interest begins compounding, and the compound interest formula begins adding up.
Here is a compound daily interest formula example
To calculate the effects of daily compounding, you will need some information.
- Amount of the principal (P)
- Interest rate (r)
- Number of time periods the money was invested or borrowed (t)
- Number of times the interest rate applies during each time period (n)
- Whether the institution compounds on weekends – if the institution does not compound on Saturdays and Sundays, it will reduce the number of times the interest is calculated.
You will need one more step before you ready to use the daily compounding formula. Most institutions and card companies advertise their rates as a yearly percentage. But if the interest compounded daily, you need to find out how much to apply to the compounding days. If the annual interest rate is 23.99%, you simply divide this by 365 to find r. You might note that some card issuers calculate daily interest on 360 days, not 365. If we are using 365, the daily periodic rate for an annual rate of 23.99% is 0.657%.
The formula for creating a daily compound interest calculator Excel spreadsheet is:
A = P * (1 + r / n) ^ (n * t)
A is the value of an investment in the future. Remember that if you are the borrower, the bank is the one who will benefit from this “investment.” Let’s say that you borrowed $5,000 at 5% annual interest for 10 years.
P = 5000
R = 5/100 = 0.05 (converts percentage to decimal)
n = 365 days (or 261 days if weekends are not included)
t = 10
A = 5000 * (1 + 0.05 / 365) ^ (365 * 10)
A = $8,243.32
This makes the total amount paid at the end $8,243.32.
You could easily adjust the times, interest rates, and principal to reflect the actual number of days that the institution calculates interest using an
compound interest formula Excel spreadsheet. The example above is a continuous compound interest formula and assumes that the interest is calculated for the entire 10 years. If you wanted to see how much you would earn after 15 days, you would substitute (n * t) with 15 (t = 15/365) in the continuous compound interest calculator.
Other Things You Need To Consider
Whether you choose to create your own Excel daily compound interest calculator or use one online, you need to calculate the number of days correctly. For instance, if your bank compounds interest only on weekdays, n would be 261 business days. When you make an extra payment on a debt that you owe, you can use a reverse compound interest calculator to see how much interest you will save by paying your loan off early.
Now you understand the basics of compound interest and how your money can add up if you are saving, or how much extra you will spend when you take out a loan. Knowing this information will help you set and achieve your financial goals faster. Being a good saver, investor, or debt manager depends on a thorough understanding of how compounding works