Definition
Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods. Unlike simple interest, which only earns interest on the principal amount, compound interest allows your money to grow at an accelerating rate because you earn interest on interest. This powerful concept is often called 'the eighth wonder of the world' and is the foundation of wealth building through investing.
Formula
Where A is the final amount, P is the principal balance, r is the annual interest rate (decimal), n is the number of times interest is compounded per year, and t is the time in years.
Example
Investment Growth Example
If you invest $10,000 at a 7% annual return compounded monthly, after 20 years you would have approximately $40,275. With simple interest at the same rate, you would only have $24,000. The extra $16,275 comes entirely from compound interest. The longer your money compounds, the more dramatic the effect becomes—after 30 years, that same $10,000 would grow to over $81,000.