There are two primary ways of calculating interest – simple interest and compound interest. Let’s understand how these ways work1 –
1. Simple Interest
Under this method, you earn interest on the amount invested. The deposited amount remains constant, and interest is calculated over the chosen tenure.
The formula for simple interest calculation is as follows –
Simple interest = (P X R X T)
Where,
P = Principal or the deposited amount
R = Rate of interest in decimals
T = Chosen tenure in years.
For example, if you happen to deposit Rs.1 lakh for 5 years at an assumed interest rate of 12% per annum, the simple interest for the same would thus be calculated as –
Simple interest = Rs.1 lakh X 0.12 X 5 = Rs.60,000
Amount on maturity = Rs.1 lakh + Rs.60,000 = Rs.1.6 lakhs
2. Compound Interest
Compound interest is where the interest keeps on compounding (increasing) after each calculation. Under this method, the deposited amount keeps increasing as the interest earned is added to it. The subsequent interest is calculated on the increased principal, i.e., the deposited amount and the interest earned on it.
Thus, compound interest gives increasing returns and can help in enhancing the corpus. The formula to calculate the amount on maturity under the compound interest method is as follows –
Amount = P (1 + R) ^T
If the compounding is done more than once during the year, the formula changes as follows –
Amount = P (1 + R/N) ^ (T X N)
Where,
P = principal or the deposited amount
R = rate of interest in decimals
T = deposit tenure
N = frequency of compounding
For instance, if you deposit Rs.1 lakh for 5 years at a rate of 12% per annum, the amount would be calculated as follows –
Amount = Rs.1 lakh (1 + 0.12) ^ 5 = Rs.176,234.
If the interest is compounded half-yearly, the frequency will become 2. In this case, the amount would be calculated as follows –
Amount = Rs.1 lakh (1 + 0.12/2) ^ 5 X 2 = Rs.179,085
An ISO 9001:2015 
