How compound interest is calculated
Compound interest is interest earned on both your original principal and the interest already accumulated. The more frequently interest compounds, the faster your money grows.
Formula: A = P(1 + r/n)ⁿᵗ + PMT × [(1 + r/n)ⁿᵗ − 1] / (r/n)
where P = principal, r = annual rate, n = compounding frequency per year, t = years, PMT = regular contribution
Worked example with real numbers
Starting amount: $10,000 | Monthly contribution: $300 | Annual rate: 7% | Compounding: monthly | Term: 20 years | Inflation: 3%
| Component | Calculation | Result |
|---|
| Growth of $10,000 | $10,000 × (1 + 0.07/12)^240 | $40,065 |
| Growth of contributions | $300 × [(1.005833)^240 − 1] / 0.005833 | $196,714 |
| Total deposits | $10,000 + ($300 × 240) | $82,000 |
| Total balance | Combined | $236,779 |
| Inflation-adjusted (real) | ÷ (1.03)^20 | $131,000 |
| Interest earned | $236,779 − $82,000 | $154,779 |
| Monthly 4% draw | $236,779 × 0.04 ÷ 12 | $789/mo |
Common mistakes to avoid
- Ignoring compounding frequency. Daily compounding on 5% APR yields 5.13% effective annual rate. Monthly yields 5.12%. The difference is small but compounds meaningfully over 30 years.
- Confusing APR and APY. APR (Annual Percentage Rate) is the stated rate. APY (Annual Percentage Yield) reflects compounding. When comparing savings accounts, always compare APY.
- Not accounting for inflation. $236,000 in 20 years buys roughly what $131,000 buys today at 3% inflation. The "real value" output shows this clearly — use it for retirement planning.
- Withdrawing during downturns. The formula assumes uninterrupted compounding. Withdrawing during a market crash permanently removes principal that would have recovered and grown.
- Underestimating small increases. Adding $100/month more to the above example adds $65,500 to the 20-year balance — a 7:1 return on the extra contributions.
Related tools and reading
Use the Retirement Planner to see compound interest applied to a full retirement projection with contributions. The FIRE Calculator tells you when compounding gets you to financial independence. The Debt Payoff Calculator shows compound interest working against you on loans. Read our FIRE Guide and 401(k) Limits 2026 for strategies that maximise tax-sheltered compounding. See how much of that growth inflation will actually erode with the Inflation Calculator.