By Wendy Helfenbaum on March 20, 2023
Estimated reading time: 6 minutes

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

By Wendy Helfenbaum on March 20, 2023
Estimated reading time: 6 minutes

Watch your money grow—or calculate how much money you will owe in total—with the MoneySense compound interest calculator. Here’s how it works.

Compound interest calculator: bar graph of money exponentially growing

Image by kstudio on Freepik

How to use this compound interest calculator

Input the following information into the compound interest calculator:

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.

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How do you calculate compound interest on savings and investments?

To calculate compound interest and the future value of your assets or investments over time, it’s helpful to use a free online financial calculator (also known as a time value of money—a.k.a. TVM—calculator). Simply plug in your initial investment, your additional contributions or loans, how long you’re allowing your money to grow or how long you’re borrowing it, and the estimated annual interest rate.

Compound interest calculators detail the exponential growth of your money, so you can project how long it will take to achieve your savings goals—whether it’s saving for a house or for retirement. The calculator also shows the exponential growth of a debt, so you can see how much it will grow if you don’t pay it down.

Let’s say you invest $1,000 for one year, with interest compounding monthly. By the end of that year, you’ll have earned $1,051. If you invest $5,000 for 10 years with interest compounding annually, you’ll get $8,144.

Compound interest: Monthly for one year

Let’s look at the monthly compounded interest, starting with $1,000.

Principal	$1,000
Annual interest rate	5%
Compounding periods/year	12
Year(s)	1
Total value of investment	$1,051
Interest earned	$51

Compound interest: Annually for 10 years

Now, let’s look at the annual compounded interest, starting with $5,000.

Principal	$5,000
Annual interest rate	5%
Compounding periods/year	1
Year(s)	10
Total value of investment	$8,144
Interest earned	$3,144

When does compound interest work against you?

Compound interest is a lot less exciting when calculated on loans or credit card debt, explains Craig.

“Many Canadians pay the minimum payment on their credit card and wonder why they never seem to [be able to] pay it off,” he notes.

If, in year one, you have a $10,000 credit card debt with an interest rate of 22% and you only make the 5% minimum payment—$500 a year—your balance will be $11,500 at the end of that year.

“Here’s when the compounding factor comes in: Your interest will be calculated on that new balance of $11,500 for year two, and if you make that same minimum payment—say $575, or 5%—your new balance after year two goes to $13,225. Your credit card debt will double by year six if you [keep] only paying the minimum, so you’d owe about $20,000. That’s where Canadians [can] get into trouble,” adds Craig.

How to make compound interest work for you

To benefit the most from the magic of compound interest, start saving early and contributing to your investment accounts, says Craig.

“If you’ve allocated an investment stream in your 20s, that will compound dramatically for the next 30 to 40 years,” he says. “That’s going to be the difference between retiring on a nice income that pays all your expenses versus delaying your retirement or perhaps not retiring at all.”

Pay yourself first instead of putting away money after your expenses are met, suggests Craig, and set up automatic withdrawals so you can make frequent tax-free savings account (TFSA) or registered retirement savings plan (RRSP) contributions.

“With pre-authorized contributions, you’re earning interest on top of your payments as well,” he explains. “And it gets even better: If there’s a dip in the market, you’re taking advantage of dollar cost averaging—buying at low unit cost.” By investing small amounts regularly over time, rather than larger lump sums less often, you reduce the risk of making an ill-timed investment decision.

Reap the benefits of compound interest by investing early and often and choosing a product that offers compound interest that’s calculated frequently. Then, watch your money grow and enjoy the higher return.