Compound Interest Explained: How Money Grows Over Time

Compound interest means you earn interest on your interest. Each period, the interest is added to the balance, and the next period's interest is worked out on the larger amount. Over a long time this snowball effect adds up.

The formula

A = P * (1 + r/n)^(n * t)

A = final amount
P = starting amount
r = annual rate as a decimal (5% = 0.05)
n = times compounded per year
t = number of years

An example

Put in 1,000 at 5 percent a year, compounded yearly, for 10 years. The result is 1,000 x 1.05^10 = about 1,628.89. Simple interest would give only 1,500, because it never earns interest on interest. The extra 128.89 is the compounding effect.

Does frequency matter?

A little. The same 1,000 at 5 percent for 10 years, compounded monthly, grows to about 1,647.01. More frequent compounding helps, but the gain is small compared with the effect of time and the rate.

The Rule of 72

Divide 72 by the interest rate to estimate how many years it takes to double your money. At 6 percent, it takes about 12 years. At 8 percent, about 9 years. At 5 percent, about 14.4 years, which matches the formula closely.

What helps most

• Start early. Time is the biggest factor.
• Add regularly. Steady monthly contributions grow far faster than a single deposit.
• Watch fees. A 1 percent yearly fee takes a large bite out of long-term growth.

It works against you on debt

The same effect makes credit card balances grow quickly when only the minimum is paid. Check the cost of borrowing in the Loan Calculator. To project savings with monthly additions, use the Compound Interest Calculator, and compare results with the Percentage Calculator. These figures are estimates, not financial advice, and real returns are never guaranteed.