Simple vs. compound interest, explained
Why the same rate can produce very different results over time.
Quoted the same 8% rate, a simple-interest instrument and a compound-interest one produce identical results for exactly one year, and diverge more with every year after that. That gap comes from two fundamentally different formulas that happen to agree at exactly one point, not from any rounding quirk.
Two different formulas
- Simple interest is calculated only on the original principal, every year, for the whole term:
Interest = P × R × T / 100. Whether it’s year 1 or year 20, the interest earned that year is always the same flat rupee amount: growth is a straight line. - Compound interest is calculated on the principal plus whatever interest has already accumulated:
Amount = P × (1 + R/100)^T. Each year’s interest is itself added to the base the next year’s interest is calculated on: growth curves upward, not a straight line.
That one difference (whether interest earns further interest, or just sits alongside the principal doing nothing) is the entire distinction. Everything else about the two formulas follows from it.
The gap widens the longer you wait
â‚ą1,00,000 at 8% for 10 years, using the real computeSimpleInterest formula: simple interest totals â‚ą1,80,000 (â‚ą80,000 interest, a flat â‚ą8,000 every single year). Compound interest on the identical principal and rate totals â‚ą2,15,892 (â‚ą1,15,892 interest): â‚ą35,892 more, purely from interest earning interest on top of interest.
| Years | Simple interest total | Compound interest total | Gap |
|---|---|---|---|
| 5 | â‚ą1,40,000 | â‚ą1,46,933 | â‚ą6,933 |
| 10 | â‚ą1,80,000 | â‚ą2,15,892 | â‚ą35,892 |
| 20 | â‚ą2,60,000 | â‚ą4,66,096 | â‚ą2,06,096 |
| 30 | â‚ą3,40,000 | â‚ą10,06,266 | â‚ą6,66,266 |
Simple interest grows in a straight line: ₹8,000 more every year, no matter how long the money sits. Compound interest grows on a curve that gets steeper the longer it runs, because the base it’s calculated on keeps growing too. By year 30, compounding hasn’t just added a bit more: the same ₹1,00,000 principal has produced almost 3x as much total interest as simple interest did, at the identical 8% rate.
See how compounding grows a deposit at different rates and frequencies.
Work out interest on a non-compounding loan or deposit quickly.
Where each actually shows up
Most everyday savings and investment products (fixed deposits, PPF, EPF, mutual funds) compound. Simple interest shows up mainly in a handful of short-term loan products and a few older, specific instruments. When comparing two products’ quoted rates, check which convention each one actually uses before assuming the higher headline number wins: a compounding 7% can end up paying more than a simple-interest 8% over a long enough term.
The formula matters most exactly where it’s easiest to overlook: long tenures. Over a single year the two are nearly identical; over 20–30 years, the horizon most retirement and long-term goal planning actually runs on, the difference compounds (quite literally) into hundreds of thousands of rupees on the same starting amount. For a quick mental check on how fast a compounding rate actually grows money, without running the full formula, the Rule of 72 estimates doubling time in one division — though it needs a different formula once simple interest is involved.
All figures are indicative and for educational purposes only, not financial advice.
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