Compound interest, explained without the hype

Simple versus compound

Simple interest is paid only on the original amount. ₹1,00,000 at 8% simple interest earns ₹8,000 every year, forever. Compound interest is paid on the original amount plus everything earned so far, so the annual earning grows each year.

After ten years at 8%, simple interest yields ₹1,80,000 and annual compounding yields about ₹2,15,892. The gap is entirely interest that itself earned interest.

Frequency is a real, if modest, effect

The more often interest is added to the balance, the sooner it starts earning. At 8% a year, annual compounding gives 8% effective; quarterly gives about 8.24%; monthly about 8.30%. The differences are small but free, which is why compounding frequency is worth checking on a deposit.

The rule of 72

Divide 72 by the annual rate to estimate how many years money takes to double. At 8%, about nine years; at 12%, about six. It is an approximation that works well between roughly 6% and 10% and drifts at extremes, but it is accurate enough for a mental check.

Two things that quietly reduce the result

Tax and inflation both work against compounding, and neither appears in the headline number. Interest on most deposits is taxed in the year it accrues, so the amount that actually compounds is lower than the gross figure.

Inflation reduces what the final amount buys. A deposit returning 7% while prices rise 6% has grown by about 1% in real terms. This is why long-horizon savings are usually weighted towards assets that have historically outpaced inflation, despite their volatility.