What Is Compound Interest?
Learn how compound interest works, why Einstein called it the eighth wonder of the world, and how to harness its power for your savings.
The Power of Compound Interest
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. In simple terms: you earn interest on your interest.
Simple vs Compound Interest
Simple Interest: $1,000 at 10% for 10 years = $1,000 + ($1,000 × 10% × 10) = $2,000
Compound Interest (annual): $1,000 at 10% for 10 years = $1,000 × (1.10)¹⁰ = $2,593.74
The difference: $593.74 — just from compounding!
The Compound Interest Formula
A = P(1 + r/n)^(nt)
Where:
- A = Final amount
- P = Principal
- r = Annual interest rate
- n = Compounding frequency per year
- t = Time in years
Compounding Frequency Matters
| Frequency | $10,000 at 8% for 20 years |
|---|---|
| Annual | $46,610 |
| Monthly | $49,268 |
| Daily | $49,530 |
The Rule of 72
A quick way to estimate how long it takes to double your money: divide 72 by the interest rate.
At 8% interest: 72 ÷ 8 = 9 years to double your money.
Start Early — It's Everything
Investing $5,000/year from age 25 to 65 at 8% = $1.4 million Investing $5,000/year from age 35 to 65 at 8% = $611,000
Starting 10 years earlier more than doubles your final balance.