Compound Interest Simply Explained: Your Money Making Money
A beginner-friendly guide to compound interest with visual examples and real-world scenarios.
Compound interest is often called the eighth wonder of the world. But what exactly is it, and why does it matter?
Simple vs Compound Interest
Imagine you deposit $1,000 at 10% annual interest.
Simple Interest
You earn $100 every year, always on the original $1,000.
- Year 1: $1,100
- Year 5: $1,500
- Year 10: $2,000
Compound Interest
You earn interest on your principal AND on previously earned interest.
- Year 1: $1,100
- Year 5: $1,611
- Year 10: $2,594
The difference: $594 more over 10 years, with zero extra effort.
The Three Variables That Matter
1. Rate of Return
Higher rates create dramatically different outcomes over time.
2. Time
This is the most powerful variable. Starting 10 years earlier can matter more than saving twice as much.
|-----------|---------------|------------------------|
Starting at 25 with $200/month beats starting at 35 with $400/month!
3. Compounding Frequency
- Annually: Interest added once a year
- Monthly: Interest added 12 times a year
- Daily: Interest added 365 times a year
More frequent compounding = slightly higher returns.
The Rule of 72
Quick estimation: 72 / interest rate = years to double
- At 6%: 72/6 = 12 years
- At 8%: 72/8 = 9 years
- At 12%: 72/12 = 6 years
Compound Interest Works Against You Too
Credit card debt at 20% APR compounds against you. A $5,000 balance with minimum payments can take 20+ years to pay off and cost $10,000+ in interest.
Use our [Compound Interest Calculator](/en/compound-interest-calculator) to see your money grow.