Compound Interest

Interest calculated on both the original principal and accumulated prior interest, causing wealth (or debt) to grow exponentially over time.

Unlike simple interest — calculated only on the original principal — compound interest adds earned interest back to the base, so each subsequent calculation is on a larger amount. Over long periods this creates exponential rather than linear growth. The formula is A = P(1 + r/n)^(nt), where P is principal, r is annual rate, n is compounding periods per year, and t is years.

Compounding frequency matters significantly. Interest compounded daily grows faster than monthly, which grows faster than annual compounding. The "Rule of 72" provides a quick mental shortcut: divide 72 by the annual interest rate to estimate how many years it takes to double your money. At 8% annual growth, money doubles roughly every 9 years; at 6%, roughly every 12.

Compound interest works against borrowers as powerfully as it works for savers. Credit card debt compounding daily at 25% can snowball rapidly if only minimum payments are made. Starting to invest early matters far more than the amount invested — a 25-year-old investing $5,000 once will often outperform a 35-year-old who invests $10,000 once, given enough time and the same return.

This definition is for informational and educational purposes only. Nothing on Finance Compass constitutes financial, investment, or trading advice. Always conduct your own research and consult a qualified professional before making financial decisions.