Compound Interest

What Is Compound Interest?

Compound interest is the process where interest earned on an investment or savings account is reinvested so that future interest is calculated on both the original principal and previously earned interest. Over time, this compounding effect can significantly increase the value of an investment.

Unlike simple interest, which only applies to the original amount invested, compound interest allows earnings to generate additional earnings.

Why It Matters

Compound interest is one of the most powerful forces in long-term investing and saving. By reinvesting interest and returns, investors can grow their wealth faster over time. The longer money remains invested, the greater the potential impact of compounding.

This concept is especially important for retirement planning, long-term investing, and consistent savings strategies.

How Compound Interest Works

Compound interest depends on several factors:

the original investment amount (principal)
the interest or return rate
how frequently interest is compounded
how long the money remains invested

When interest is compounded, earnings are added to the balance, increasing the amount that future interest calculations apply to.

Example

An investor deposits $1,000 into an account earning 5% annually. After the first year, the balance grows to $1,050. In the second year, interest is calculated on $1,050 instead of the original $1,000, resulting in a larger gain.