An annual contribution into an account that pays interest is known as an annuity. Compounding interest earns interest on any already earned. By calculating the amount, an investor can see how much his annual deposits will be worth after a set period of time. For example, an investor puts aside $100 a month in a bank account that earns 6 percent interest a year. The bank account compounds monthly. He does this for eight years.
Determine the interest rate per compounding period, the number of periods compounding and the annual contribution. In our example, 6 percent divided by 12 equals 0.005 interest per month. Multiply 8 times 12 which equals 96 times compounding. The annual contribution is $100.
Add 1 to the interest rate then raise the sum to the power of the number of times compounding. In our example, 1 plus 0.005 equals 1.005; then 1.005 raised to the power of 96 equals 1.614142708.
Subtract 1 from the number calculated in Step 2. In our example, 1.614142708 minus 1 equals 0.614142708.
Divide the number calculated in Step 3 by the interest rate per compounding period. In our example, 0.614142708 divided by 0.005 equals 122.8285417.
Multiply the number calculated in Step 4 by the annual contribution. In our example, 122.8285417 times $100 equals $12,282.86.
- K Bapps: Financial Formulas
- Federal Deposit Insurance Corporation. "Appendix A to Part 1030—Annual Percentage Yield Calculation." Accessed July 26, 2020.
- U.S. Securities and Exchange Commission. "What Is Compound Interest?" Accessed July 26, 2020.
- American Express. "APY vs. APR: The Basics About How Interest Is Calculated." Accessed July 26, 2020.
- Consumer Financial Protection Bureau. "What Is a Credit Card Interest Rate? What Does APR Mean?" Accessed July 26, 2020.
- Consumer Financial Protection Bureau. "What Is the Difference Between a Mortgage Interest Rate and an APR?" Accessed July 26, 2020.
- University of Wisconsin. "Cheat Sheet 2," Page 1. Accessed July 26, 2020.
Carter McBride started writing in 2007 with CMBA's IP section. He has written for Bureau of National Affairs, Inc and various websites. He received a CALI Award for The Actual Impact of MasterCard's Initial Public Offering in 2008. McBride is an attorney with a Juris Doctor from Case Western Reserve University and a Master of Science in accounting from the University of Connecticut.