What is compound interest?
Compound interest is when your interest earns interest of its own. The longer you leave your money invested, the faster it can grow.
How does it work?
The calculation is simple: each year, or at your chosen frequency, interest is applied to both your initial capital and the interest you've already earned.
Here's the formula I use:
Final capital = Initial capital × (1 + Interest rate / Frequency) ^ (Frequency × Duration) + Regular contributions
For example, if you invest €10,000 at 5% for 20 years with monthly contributions of €1,000, you'll see your capital grow considerably through compounding.
Applying interest
At the end of each period, such as the end of the year, interest is applied only to the existing balance, before any new contribution.
That means new contributions only start earning interest after the following period.
Adding contributions after interest
Once interest has been applied, I add the contributions accumulated during the period to the balance.
Those new contributions are then included when calculating interest for the next period. This maximises your capital's growth potential.
This method lets you simulate several years of investment growth and see how compounding affects your future returns.