What is Compound Interest?
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Unlike simple interest, which only earns returns on the principal, compound interest earns returns on returns โ creating exponential growth over time.
The Formula
A = P(1 + r/n)^(nt)
Where: A = final amount, P = principal, r = annual rate, n = compounding frequency, t = time in years
The Power of Time
The most important factor in compound interest is time. Starting early dramatically increases final results. An investor who starts at 25 will typically accumulate 2โ4ร more than someone who starts at 35 with the same monthly contribution, even though the early starter only invests for 10 more years.
Compounding Frequency Matters
The more frequently interest compounds, the more you earn. Daily compounding yields slightly more than monthly, which yields more than annual. However, for most practical purposes, the difference between monthly and daily compounding is small.