Calculating how much compound interest you'll earn may seem complicated, but it's actually simple. If your interest compounds annually, you take the annual interest rate you earn, say 2.5% and multiply it by your balance, say $10,000. 2.5% of $10,000 is $250, so you'll earn $250 in interest, bringing your balance to $10,250. To calculate the following year's interest, take the balance of $10,250, and multiply by 2.5%, which is $256.25. Your ending balance at year two is $10,506.25 ($10,250 + $256.25). 

If your interest compounds monthly, you divide your annual interest rate by the number of months in a year, or 12. The interest rate of 2.50%, expressed as a decimal is 0.025 — 0.025 divided by 12 is 0.0020833. Next, you multiply that number by your balance, or $10,000, and you get 20.833, or $20.83 in interest that month. For the next month, you multiply $10,020.83, which is your new balance, by 0.0020833, or the monthly interest rate, and you get 20.877, or $20.88 in interest. Your new balance is $10,041.71. You can continue with the same pattern for each month, and by the end of the year you'll have earned $252.88 in interest, or $2.88 more than if your account were compounded annually.

For other types of interest, such as daily, weekly or semi-annually, the process is the same. Divide your annual interest rate by 365, 52 or 2, and multiply that by your balance. Don't forget to use this new compound balance when calculating the next period's interest accumulation.

Say you open an account with $10,000, and earn 2.5% annual interest:

Simple Interest vs. Compound Interest

Beginning Balance:$10,000.00
Interest Rate: 2.50%

Simple

Time period:
Beginning
Balance
Interest
Earned
Ending
Balance

 

Year 1
$10,000.00
$250.00
$10,250.00

 

Year 2
$10,250.00
$250.00
$10,500.00
 Year 3
$10,500.00
$250.00
$10,750.00

 

Total Interest Earned:

$750.00

 

 

Compounded
Annually

Time period:
Beginning
Balance
Interest
Earned
Ending
Balance

 

Year 1
$10,000.00
$250.00
$10,250.00

 

Year 2
$10,250.00
$256.25
$10,506.25
 Year 3
$10,506.25
$262.66
$10,768.91

 

Total Interest Earned:

$768.91

 

 

Compounded
Monthly

Time period:
Beginning
Balance
Interest
Earned
Ending
Balance

 

Year 1
$10,000.00
 
Month 1
$10,000.00
$20,833
$10,020.83
 
Month 2
$10,020.83
$20,877
$10,041.71
 
Month 3
$10,041.71
$20,920
$10,062.63
 
Month 4
$10,062.63
$20,964
$10,083.59
 
Month 5
$10,083.59
$21.007
$10,104.60
 
Month 6
$10,104.60
$21.051
$10,125.65
 
Month 7
$10,125.65
$21.095
$10,146.75
 
Month 8
$10,146.75
$21.139
$10,167.89
 
Month 9
$10,167.89
$21.183
$10,189.07
 
Month 10
$10,189.07
$21.227
$10,210.30
 
Month 11
$10,210.30
$21.271
$10,231.57
 
Month 12
$10,231.57
$21.316
$10,252.88

 

Year 2
 
Month 1
$10,252.88
$21.360
$10,274.24
 
Month 2
$10,274.24
$21.405
$10,295.65
 
Month 3
$10,295.65
$21.449
$10,317.10
 
Month 4
$10,317.10
$21.494
$10,338.59
 
Month 5
$10,338.59
$21.539
$10,360.13
 
Month 6
$10,360.13
$21.584
$10,381.71
 
Month 7
$10,381.71
$21.629
$10,403.34
 
Month 8
$10,403.34
$21.674
$10,425.02
 
Month 9
$10,425.02
$21.719
$10,446.74
 
Month 10
$10,446.74
$21.764
$10,468.50
 
Month 11
$10,468.50
$21.809
$10,490.31
 
Month 12
$10,490.31
$21.855
$10,512.16
 Year 3
 
Month 1
$10,512.16
$21.900
$10,534.06
 
Month 2
$10,534.06
$21.946
$10,556.01
 
Month 3
$10,556.01
$21.992
$10,578.00
 
Month 4
$10,578.00
$22.038
$10,600.04
 
Month 5
$10,600.04
$22.083
$10,622.12
 
Month 6
$10,622.12
$22.129
$10,644.25
 
Month 7
$10,644.25
$22.176
$10,666.43
 
Month 8
$10,666.43
$22.222
$10,688.65
 
Month 9
$10,688.65
$22.268
$10,710.92
 
Month 10
$10,710.92
$22.314
$10,733.23
 
Month 11
$10,733.23
$22.361
$10,755.59
 
Month 12
$10,755.59
$22.407
$10,778.00

 

Total Interest Earned:

$778.00

 



.
© HSBC Finance Corporation 2009. All Rights Reserved.