Compound Interest Calculator | Ratehub.ca (2024)

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What is compound interest and how does it work?

For those new to the concept of compound interest, let’s go over some basics:

• Definition of compound interest

Compound interest is what happens when interest earned from a previous period is added back to your principal (the initial amount of money you invested as cash), increasing your balance and, consequently, the amount of interest you’ll earn going forward. Through the power of compound interest, your savings and investment returns can grow exponentially as interest is continuously reinvested.

The frequency of compounding can occur annually, monthly, weekly, or daily. Typically, the more regularly your interest is compounded, the faster your balance will grow.

• What is “interest on interest”?

A popular way to describe compound interest is with the phrase “interest on interest”. When you first open a savings account, for example, your principal (initial cash deposit) is the only thing earning interest. But once that interest gets added back to your principal, it’s now part of the equation. After that, you’ll be earning interest on the interest itself as it compounds - hence, the phrase “interest on interest”.

What is the differences between compound interest and simple interest

Unlike compound interest (which is interest added onto interest), simple interest is applied to the initial deposit only and does not compound. That means any interest you make won’t increase your balance and earn higher interest.

This also means that compounding periods have no effect on simple interest, as there is no compounding frequency to increase or decrease.

Here's a breakdown of how compound interest versus simple interest impacts your returns assuming:

• An initial deposit of $3,000
• An interest rate of 7%

Compound interest calculator explained

A compound interest calculator helps you project the growth of your money - whether it be in a savings account, GIC or equity investment (think stocks, ETFs, or bonds) - to see whether you’ll get your desired yield. To calculate your compound interest, fill out the following fields:

• Initial investment: the principal amount you’ll be depositing or investing
• Additional contributions: fill this out only if you plan on making regular contributions after your initial deposit or investment. Input the amount you plan on regularly contributing and select how often you expect the contributions to take place (eg. monthly, bi-weekly, etc.)
• Interest rate: the interest rate you expect to earn on your savings or investment
• Compound frequency: how frequently interest will be reinvested to the principal (eg. annually, semi-annually, etc.). Typically, savings accounts, GICs, and investments are compounded annually
• Time horizon (in years): The length of time you expect to keep your money in the account or investment

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How to maximize your savings and investments with compound interest

Now that we’ve covered the basics of compound interest, here are a few tips to make sure you’re getting the most out of it:

• Start saving and investing early

As with any saving or investing strategy, it’s wise to start as early as possible. The sooner you begin, the more powerful your compounding interest will get, and the less you’ll have to contribute out of your own pocket.

• Make additional contributions

If you’re looking to grow your money even faster, making additional contributions to your principal on a regular (or even semi-regular) basis can make a world of difference.

What is compound frequency?

Compound frequency refers to the amount of times interest is compounded within a given year. While most investments (savings, GICs, etc.) compound annually, different compound frequencies can have substantial effects on the growth of your money. Let’s use a few examples to illustrate:

• Annual

The most common compound frequency, deposits or investments that compound annually get their interest reinvested once a year. As an example, let’s say you’ve kept $10,000 in a savings account with 5% interest for five years. By the end of your fifth year, your interest has been compounded a total of five times:

As you can see, even annually compounding interest can boost your principal on its own.

• Monthly

Let’s see what would happen to that same principal deposit if the 5% interest was compounded monthly instead of yearly for five years:

As you can see, increasing the compound frequency of your deposit or investment can boost its growth over the same amount of time.

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Calculate compound interest in GICs and other investments

Because banks borrow money from their customers to lend to others, those with funds held in savings accounts are paid interest on their balance as a sort of “thank you”. Virtually all savings and GIC accounts compound interest annually.

• High-interest savings account

While a regular savings account may pay out a modest amount of interest, a high-interest savings account is just what it sounds like: a savings account that allows you to earn a higher-than-average level of interest. For example, if you deposited $1,000 into a HISA with an interest rate of 4%, after a total of 4 years you would have $1,172.

• GICs

GICs (or Guaranteed Investment Certificates) are the safest and most secure investment product you can buy. With fixed-rate GICs, your principal and prescribed interest are both guaranteed through government-backed insurance, avoiding the rollercoaster ride associated with traditional stocks.

When you purchase a GIC, you also select a term length. These can typically run anywhere from 30 days to five years, but your investment is meant to stay untouched for that length of time. While your interest can be compounded annually, you won’t actually get the full sum until your GIC reaches the end of its term.

More investment calculators

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• RRSP limit calculator
• Loan and mortgage amortization calculator

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