What is Compound Interest?
financeDefinition
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Often called 'interest on interest', it causes wealth to grow exponentially. The formula is: A = P × (1 + r/n)^(nt), where P is principal, r is annual rate, n is compounding frequency, and t is time in years.
Detailed Explanation
Albert Einstein reportedly called compound interest the 'eighth wonder of the world' — though the attribution is disputed, the sentiment is accurate. The power of compounding is demonstrated by the Rule of 72: divide 72 by your annual return rate to find how many years it takes to double your money. At 12% returns, money doubles approximately every 6 years.
Compound interest works against you in loans (you pay interest on unpaid interest) but works in your favor in investments. This is why starting to invest early — even with small amounts — produces dramatically better outcomes than investing larger amounts later.
Compare compound vs. simple interest for any investment using ToolsDock's Interest Calculator.
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