How to calculate daily compound interest
Compound interest, often called “interest on interest,” is a powerful concept in finance that enables investors to earn interest not only on their initial investment, but also on the interest that accumulates over time. In this article, we will break down the main steps involved in calculating daily compound interest.
Step 1: Understand the Formula
The formula for calculating daily compound interest is as follows:
A = P(1 + r/n)^(nt)
A = The future value of the investment
P = The initial principal (the amount initially invested)
r = The annual interest rate (in decimal form)
n = The number of times interest is compounded per year
t = The number of years
Step 2: Convert Annual Interest Rate to Daily Interest Rate
To calculate daily compound interest, you need to break down the annual interest rate into a daily rate. Divide the annual interest rate by 365 (the approximate number of days in a year):
Daily Interest Rate = Annual Interest Rate / 365
Step 3: Determine the Compounding Frequency
For daily compound interest, the compounding frequency is 365, as it compounds every day.
Step 4: Calculate the Future Value
Now that you have all the variables, plug them into the formula to calculate the future value of your investment:
A = P(1 + r/365)^(365*t)
Let’s say you invest $10,000 at an annual interest rate of 5% for three years:
P = $10,000
r = 0.05
t = 3
First, convert the annual interest rate to a daily rate by dividing it by 365:
Daily Interest Rate = 0.05 / 365 ≈ 0.000137
Now, plug these values into the formula:
A ≈ $10,000(1 + 0.000137)^1,095 ≈ $11,617.63
In this example, the future value of the investment after three years of daily compounding would be approximately $11,617.63.
In conclusion, understanding how to calculate daily compound interest can help investors predict their investment’s growth more accurately and make wiser financial decisions. With some basic math and the right formula, anyone can make this key financial calculation.