The idea behind compound interest is pretty straightforward. If you are being paid a given interest rate on an investment, and the interest is calculated at the end of the year and added to your account, you earn a flat (simple) interest rate. However, if you break the annual interest rate down into smaller increments (monthly or even daily) and calculate the interest earned to date, it can then be added to your account. As soon as it is added, the earned interest starts earning more interest, so you end up making more money on your investment.
Find the daily interest rate. Do this by dividing the annual interest rate by 365, the number of days in a year. For example, if you have a compound interest investment with an annual rate of 7.30 percent, divide 7.30 by 365 to get a daily rate of 0.02 percent.
Multiply the daily interest rate by the number of days in the period between compounding interests used for the investment. This gives you your periodic interest rate. Suppose interest is calculated and added to your balance once a week. If you have a daily rate of 0.02 percent, multiply 0.02 by 7 to get the periodic interest rate for one week (0.14 percent in our example).
Multiply the periodic interest rate by the balance in your account. Then add the result to the balance of your investment. If your weekly rate is 0.14 percent, and the value of your investment is $10,000, then multiply $10,000 by 0.14 percent to get $14 interest earned for the week, bringing your account ending balance to $10,014.
Repeat Steps 2 and 3 using the ending balance from Step 3 as your new starting balance, and continue until you complete one year. In the example from Steps 1 to 3, you would start the next week with $10,014. The interest for this second calculation works out to $14.02, bringing the balance after two weeks to $10,028.02.
Although it’s wise to understand how to calculate a compound interest investment, in practice, it’s tedious and time-consuming. Fortunately, there are a number of good compound interest calculators available free on the Internet. See Resources for a link to one.