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This article was co-written by Chad Seegers, CRPC®. Chad Seegers is a financial planner (CFP®) and retirement consultant (CRPC®) at Insight Wealth Strategies in Houston, Texas. Prior to that, Chad was a private wealth consultant at Sagemark Consulting for over 10 years, where he was selected as a member of Private Wealth Services. With over 15 years of experience, Chad specializes in retirement planning advice for employees and managers of the oil and gas industry, as well as investment strategy and legacy advice. Chad is a supporting member of the World Affairs Council and a leader of the Global Independence Center (GIC).
This article has been viewed 40,119 times.
Sometimes, to calculate the interest earned from a savings account, we simply multiply the interest rate by the principal amount. However, in most cases, it is not so easy. For example, many savings accounts are listed with one-year interest rates but compounded monthly. Each month, a portion of interest will be calculated and added to the principal, affecting the interest of the following months. The gradual and continuous addition to principal is called compounding, and the easiest way to calculate future earnings is to use the compound interest formula. Read on to learn more about the pros and cons of this interest calculation.
Steps
Calculate compound interest
- (P) is the principal amount, (r) is the one-year interest rate, and (n) is the number of times the interest is compounded during the year. (A) is the account balance calculated under the effect of compound interest.
- (t) is the time the interest is accrued. This number should match the interest rate used (for example, if interest is calculated on an annual basis, then (t) should be the number or fraction of the year). If less than a year, divide the total number of months by 12 or the total number of days divided by 365.
- Principal (P) is the initial deposit or existing funds used to calculate interest.
- The interest rate (r) should be given as a decimal. 3% should be filled in the formula as 0.03. To get this number, you just need to divide 3 by 100.
- The value (n) is the number of times interest is calculated and compounded to the principal (compounding) in a year. The most common is compounding monthly (n=12), quarterly (n=4) and yearly (n=1). However, there may still be other options, depending on the specifics of your savings account. [1] X Research Source
- The compounded daily interest is calculated in the same way, except that in this case the variable (n) is 365 instead of 4 as above. [2] X Research Source
- This equation can be further reduced by performing the calculation enclosed in brackets: first+0,0125=first,0125{displaystyle 1+0.0125=1.0125} . Now, we get: A=20,000,000 won(first,0125)4{displaystyle A=20,000,000(1,0125)^{4}} copper.
- Note that this number is slightly higher than what you would expect to get when the annual interest rate is quoted – 20,000,000 won∗5%{displaystyle 20,000,000*5%} copper. It shows how important it is to understand how and when interest is compounded!
- The profit earned is the difference between A and B. So the total profit is 21.020,000 won−20,000,000 won=1,020,000 won{displaystyle 21,020,000-20,000,000=1,020,000} copper.
Calculate interest with regular capital contribution
- Another simple method is to separate the compounding interest on the principal from the interest earned on the capital contribution (or payment/PMT). To get started, calculate principal interest using the cumulative savings formula.
- As can be seen, with this formula, you can calculate the interest earned on the savings account that is deposited more monthly and compound interest by day, month or quarter. [4] X Research Sources
- The principal “P” may also represent the account value at the selected time interest starts.
- The “r” interest rate indicates the interest paid to the account each year. It should be expressed as a decimal in the formula. That is, a 3% interest rate should be expressed as 0.03. To get this decimal, you just take the interest rate as a percentage divided by 100.
- “n” is simply the number of compoundings in a year. That would be 365 if compounded by day, 12 if by month, and 4 in case of quarter.
- Similarly, “t” represents the number of years used to calculate interest. It can be the number of years or part of the year if the interest period is less than one year (eg 0.0833 (1/12) for a period of 1 month). [5] X Research Sources
Use a spreadsheet to calculate compound interest
- Instead of accumulating interest, the future value function is designed to calculate the amount to be paid to balance the existing account as it continuously accrues interest. Therefore, the function will automatically give a negative result. To resolve this issue, type =−first∗FDRAW({displaystyle =-1*FV(}
- Similar data parameters, separated by commas, are used in the FV function, but they are not exactly the same as the parameters we used above. For example, “interest rate” here is r/n{displaystyle r/n} (annual interest divided by “n”). It will be calculated automatically in the brackets part of the FV function.
- The “nper” parameter here is the variable n∗t{displaystyle n*t} – the total number of compounded interest periods and the total number of capital contributions. In other words, if the PMT is non-zero, the FV function will assume that you contribute the amount of PMT capital through each and every period specified by “nper”.
- Note that this equation is most common for (calculations like) mortgage repayment over time with recurring payments. For example, if planning to pay monthly installments over 5 years, “nper” would be 60 (5 years * 12 months).
- PMT is the amount of capital contribution periodically during the whole period (part of capital contribution per “n”).
- “[pv]” (or Present Value) is the principal account – your account’s initial balance.
- The last variable, “[type]” (type), can be left blank in this calculation (the function then returns itself to zero).
- The FV function allows you to perform simple calculations inside the brackets of a function formula, such that a complete FV function might take the form −first∗FDRAW(.05/twelfth,twelfth,2,000,000 won,100,000,000 VND){displaystyle -1*FV(.05/12,12,2,000,000,100,000,000)} . It shows 5% annual interest compounded monthly for 12 month term and during that time you contribute 2,000,000 VND/month. At the same time, your initial balance (principal capital) is VND 100,000,000. The results obtained show how much your account has after 1 year (VND 129,674,000).
Advice
- Besides, calculating compound interest may be more complicated with non-fixed capital contribution. At this point, you need to calculate the interest of each capital contribution/payment individually (with the same formula introduced above) and it is best to use a spreadsheet to simplify the calculation.
- You can also use an online annual published interest calculator to determine the interest earned on a savings account. Search the internet for “annual interest calculator” for countless sites offering this free service.
This article was co-written by Chad Seegers, CRPC®. Chad Seegers is a financial planner (CFP®) and retirement consultant (CRPC®) at Insight Wealth Strategies in Houston, Texas. Prior to that, Chad was a private wealth consultant at Sagemark Consulting for over 10 years, where he was selected as a member of Private Wealth Services. With over 15 years of experience, Chad specializes in retirement planning advice for employees and managers of the oil and gas industry, as well as investment strategy and legacy advice. Chad is a supporting member of the World Affairs Council and a leader of the Global Independence Center (GIC).
This article has been viewed 40,119 times.
Sometimes, to calculate the interest earned from a savings account, we simply multiply the interest rate by the principal amount. However, in most cases, it is not so easy. For example, many savings accounts are listed with one-year interest rates but compounded monthly. Each month, a portion of interest will be calculated and added to the principal, affecting the interest of the following months. The gradual and continuous addition to principal is called compounding, and the easiest way to calculate future earnings is to use the compound interest formula. Read on to learn more about the pros and cons of this interest calculation.
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