See exactly how your savings and investments will grow over time with the power of compound interest.
Compound interest is one of the most powerful concepts in personal finance. Unlike simple interest, which is only calculated on your original deposit, compound interest earns returns on both your principal and your previously accumulated interest. Over long periods of time, this creates an exponential growth curve that Albert Einstein allegedly called "the eighth wonder of the world."
The formula for compound interest is:
Where A is the final amount, P is your initial principal (starting deposit), r is the annual interest rate expressed as a decimal, n is the number of times interest compounds per year, and t is the number of years your money is invested.
For example, if you invest $10,000 at a 7% annual rate compounded monthly for 20 years, your investment would grow to approximately $40,387. That means you earned over $30,000 in interest on a $10,000 deposit. Add monthly contributions to the equation and the numbers become even more dramatic.
At its core, compound interest means earning interest on your interest. Imagine you deposit $1,000 in a savings account that pays 5% annually. After year one, you have $1,050. In year two, you earn 5% on $1,050 (not just the original $1,000), giving you $1,102.50. Each year, the base amount grows, and your earnings accelerate.
This is why starting early matters so much. An investor who begins at age 25 and contributes $200/month at 7% will have significantly more at retirement than someone who starts at 35 with the exact same contributions. Time is the single most important variable in the compound interest equation.
Simple interest only calculates returns on the original principal. If you invest $10,000 at 7% simple interest for 20 years, you earn $14,000 in interest for a total of $24,000. With compound interest at the same rate compounded monthly, you end up with over $40,000. The difference is over $16,000, and it only grows wider with longer time horizons.
The more frequently interest compounds, the more you earn. Annual compounding applies interest once a year. Monthly compounding applies it twelve times a year, and daily compounding applies it 365 times. In practice, the difference between daily and monthly compounding is small (often just a few dollars per year on moderate balances), but the jump from annual to monthly compounding is meaningful. Most savings accounts and investment vehicles compound daily or monthly.