What Is Compound Interest?
Compound interest is interest earned on both your original principal and the interest you've already accumulated. It's why small amounts invested early can grow into significant wealth — and why carrying debt can feel like running uphill.
Simple analogy: Simple interest is like getting paid a salary — the same amount every year. Compound interest is like getting a raise every year based on your current salary. The longer it goes, the bigger the gap.
The Compound Interest Formula
Where:
- A = Final amount
- P = Principal (starting amount)
- r = Annual interest rate (as a decimal — 7% = 0.07)
- n = Compounding frequency per year (12 = monthly, 365 = daily)
- t = Time in years
A Real-World Example
You invest $10,000 at 7% annual return, compounding monthly:
| Year | Balance | Interest earned that year |
|---|---|---|
| 1 | $10,723 | $723 |
| 5 | $14,176 | $934 |
| 10 | $20,097 | $1,325 |
| 20 | $40,388 | $2,658 |
| 30 | $81,136 | $5,343 |
That $10,000 becomes $81,136 — $71,136 in interest, from zero additional contributions. The interest earned in year 30 alone ($5,343) is more than the total interest earned in the first five years combined.
The Rule of 72
A quick mental math shortcut: divide 72 by your interest rate to estimate how many years it takes for money to double.
Examples:
- At 6%: 72 ÷ 6 = 12 years to double
- At 8%: 72 ÷ 8 = 9 years to double
- At 12%: 72 ÷ 12 = 6 years to double
- At 3% (savings account): 72 ÷ 3 = 24 years to double
Compounding Frequency Matters
How often interest compounds affects the total. Daily compounding beats monthly, which beats annual — but the difference is smaller than most people expect:
| Compounding | $10,000 at 7% for 10 years |
|---|---|
| Annually | $19,672 |
| Quarterly | $20,016 |
| Monthly | $20,097 |
| Daily | $20,136 |
Starting Early Is the Biggest Lever
Time is the most powerful variable in the compound interest equation. Two investors, same outcome:
- Alex invests $5,000/year from age 25–35 (10 years, $50,000 total), then stops
- Jordan invests $5,000/year from age 35–65 (30 years, $150,000 total)
Assuming 7% return: Alex has more money at 65 — despite investing $100,000 less. Starting 10 years earlier overcomes three times as many years of contributions.
Use our compound interest calculator to model your own scenarios.