Compound interest calculator: How to use one and how interest grows

• Initial investment: This is how much you are paying for the investment or putting into the savings account. If you are calculating a loan or debt, this is the amount of money you are borrowing.
• Additional contributions: Here, add how much more money you will be putting toward the investment or savings. For loans or debts, this counts as additional money you will be borrowing on top of the initial amount.
• Interest rate: Input the amount of interest you will be earning or charged, expressed as a percentage. 
• Compound frequency: Select how often the interest will be compounded—this is “interest on interest” earned or owed. Your options include: weekly, monthly, quarterly and annually. For example, the interest on some lines of credit is compounded monthly, and many investments have annual compounded interest.
• Total value of investment: This amount will appear when you input the above into the calculator. This represents how much your investment should be worth or how much you will owe in total. 
• Note: The text in the calculator mentions investments, but it also works for debts and loans.

Why compound interest matters

Compound interest is kind of like getting paid twice on your investment. It can also work against you if you owe money. Using a compound interest calculator can help you figure out the future value of your savings, or how much you’ll owe on a debt. Here’s what you need to know.

What is compound interest?

Compound interest is earned on money that has already earned interest. Sounds tricky, but it’s one of the best ways Canadians can build wealth because it’s more lucrative than traditional simple interest, says Sheldon Craig, a financial planner with Alaphia Financial Wellness in Osoyoos, B.C. 

“For example, if you have a $10,000 investment and you earn 5% on that, the first year you will have $10,500. The next year, you’ll earn interest on that $10,500, plus another 5%,” explains Craig. 

If you purchase an investment featuring compounded interest, your balance will grow over time as your interest earns interest on itself. Your original investment can be compounded yearly, monthly, weekly or daily—it’ll grow faster when it’s compounded more frequently over the term of your investment.

It works the same way with credit and debt. Say, for example, you don’t pay your line of credit interest or a credit card bill on time. You could be paying interest on top of interest. 

What’s the difference between nominal interest rates and effective interest rates?

The big difference between nominal and effective interest is what’s earning the interest. A nominal interest rate is simple interest, with earnings calculated on the principal investment. Effective interest includes the compounding period, enabling you to grow your money, explains Craig. 

“Compounding is beneficial when you’re saving money because you’re earning money on the yield that was originally earned,” he says.

What types of products use compound interest?

Financial products offering compound interest include: savings accounts, guaranteed investment certificates (GICs), stocks, bonds and exchange-traded funds (ETFs). Credit cards, loans and mortgages also use compound interest—but these don’t work in your favour the way investment products do, because what you owe is compounded.