Compound interest not only allows your original savings total to earn money, but also the interest. Annual compounded interest means interest on the original investment and any earned interest is calculated every year. To illustrate the effect of compound interest, non-compounded 5 percent interest on $100 would earn $5 each year, but 5 percent compounded interest would earn $5, $5.25, $5.75, $6.55 and $7.63 in five consecutive years. The amount you earn is increased by the compounding effect of its interest.
1. Add one to the annual interest rate, in decimal form. As an example, if your savings account offered 5 percent interest, you would add 1 to 0.05 to get 1.05.
2. Raise this number to the nth power, where "n" is the number of years into the future for which you wish to calculate interest. In the example, to calculate the interest 20 years from now, you would raise 1.05 to the 20th power, which results in 2.6533.
3. Multiply this figure by the original savings total to calculate your total balance at the future date. In the example, if you had originally saved $20,000 then multiply this figure by 2.6533 to get a balance of $53,066.
4. Subtract the original investment amount, if you want only wish to calculate the interest earned. In the example, subtracting $20,000 would give you the total interest earned as $33,066.
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