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Compounding can greatly increase your investment returns over time. When an investment compounds, it adds the interest it earned for a particular period to its existing balance. The next period’s interest calculation is based on the higher balance, and the interest is again reinvested to grow the investment. As time passes and the investment continues to compound, its value grows at an increasing rate. A semiannually-compounding investment, such as a certificate of deposit, reinvests its interest payments twice a year. You can calculate a semiannually-compounding investment’s future value to determine the amount to which the investment will grow.
Determine the initial amount of an investment, the number of years that you will own the investment and the investment’s annual interest rate. For example, assume you buy a five-year, $20,000 certificate of deposit that pays 6 percent annual interest compounded semiannually.Step 2
Plug the values into the following formula: A x [(1 + (R/2))^(N x 2)]. In the formula, "A" represents the initial investment amount, "R" represents the annual interest rate as a decimal and "N" represents the number of years you will own the investment. In this example, the formula would be $20,000 x [(1 + (0.06/2))^(5 x 2)].Step 3
Divide the annual interest rate by 2 and add 1 to your result. Continuing the example, divide 0.06 by 2 to get 0.03. Add 1 to 0.03 to get 1.03. This leaves $20,000 x [1.03^(5 x 2)].Step 4
Multiply the numbers in parentheses. In this example, multiply 5 by 2 to get 10, which leaves $20,000 x (1.03^10) in the formula.Step 5
Calculate the numbers in parentheses and multiply your result by the initial investment amount to calculate the value at the end of the investment period. Concluding the example, raise 1.03 to the 10th power to get 1.3439. Multiply $20,000 by 1.3439 to get $26,878. This means that your $20,000 investment compounded semiannually will grow to $26,878 in five years.
- If you withdraw money from your investment before the end of your holding period, you will diminish the effects of semiannual compounding and your investment will not reach your calculated value.
- Compound returns chart image by Gramper from Fotolia.com