Compound interest

Indian Economy glossary

Also called: compounding, power of compounding · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Class 7, Ch 8 "Banks and the Magic of Finance"

Meaning

Compound interest means you earn interest on your original money and also on the interest you have already earned. Your money therefore grows faster each year. The longer you keep it invested, the stronger this effect becomes.

Formula: A = P(1 + r)ⁿ

  • A = final amount
  • P = the money you start with (principal)
  • r = interest rate per period
  • n = number of periods

A quick shortcut is the Rule of 72: 72 ÷ interest rate gives roughly the number of years your money takes to double.

Example

₹1,000 at 6% a year grows like this (Class 7):

  • After year 1: ₹1,060
  • After year 2: ₹1,123.60 (year 2 interest is 6% of ₹1,060 = ₹63.60)
  • After 12 years: ₹2,012.20

This matches the Rule of 72: 72 ÷ 6 = 12 years to double.

Don't confuse with

  • Simple interest: interest is paid only on the original amount. At 6% simple interest, ₹1,000 earns a flat ₹60 every year.

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