| Definition |
Interest calculated on the initial principal and also on the accumulated interest of previous periods. |
Interest calculated only on the original principal amount throughout the investment period. |
| Interest Calculation |
Interest is added to the principal after each compounding period (annually, quarterly, monthly, etc.). |
Interest is calculated only on the principal amount, no compounding effect. |
| Formula |
A = P(1 + r/n)^(nt), where n = number of compounding periods per year. |
I = P × r × t, where I = interest earned. |
| Interest Amount |
Interest grows exponentially over time due to compounding effect. |
Interest grows linearly and remains constant for each period. |
| Effect of Time |
Longer time periods significantly increase total interest earned. |
Interest increases proportionally with time; no acceleration. |
| Principal Amount |
Principal increases over time as interest is reinvested. |
Principal remains constant throughout the investment. |
| Rate of Interest |
Effective interest rate depends on compounding frequency. |
Rate of interest is straightforward, applied once per period. |
| Compounding Frequency |
Interest is compounded at regular intervals (annually, semi-annually, quarterly, monthly, daily). |
No compounding; interest paid or calculated on principal only. |
| Use Cases |
Used in savings accounts, fixed deposits, mutual funds, loans with compounded interest. |
Common in simple loans, short-term investments, and some bonds. |
| Returns |
Higher returns over long term due to compounding effect. |
Lower returns compared to compound interest for the same rate and period. |
| Complexity |
More complex calculation, requires understanding of compounding periods. |
Simple and easy to calculate. |
| Example |
Invest ₹10,000 at 8% compounded annually for 3 years results in more interest than simple interest. |
Invest ₹10,000 at 8% simple interest for 3 years results in interest only on principal. |
| Impact on Loans |
Borrowers pay more interest over time due to compounding. |
Borrowers pay less interest compared to compound interest loans. |
| Impact on Investments |
Investors benefit from compounding, accelerating wealth creation. |
Investors earn steady, predictable interest without growth acceleration. |
| Tax Implications |
Interest earned is taxable each year on accrued interest even if not withdrawn. |
Interest earned is taxed only on actual interest received. |
| Ideal For |
Long-term investors who want to maximize returns by reinvesting interest. |
Short-term or simple investments where reinvestment of interest is not intended. |
| Effect of Inflation |
Helps beat inflation better due to compounding returns. |
May not keep pace with inflation over long periods. |
| Psychological Effect |
Encourages saving and reinvestment due to visible growth. |
May not motivate investors to reinvest since interest is fixed. |
| Summary |
Compound interest grows wealth faster by earning interest on interest. |
Simple interest provides straightforward, fixed interest based on principal. |
Compound Interest vs Simple Interest