Compound Interest, Explained Simply

Simple interest pays you a fixed amount each year. Compound interest pays you interest on the interest you already earned. That difference looks small at first and enormous later.

The Formula

Compound interest follows the future-value formula:

Where A is the amount after time t, P is the starting principal, r is the annual interest rate and n is how many times interest compounds per year.

A Concrete Example

Invest $1,000 at 5% compounded annually for 10 years:

Year 1: $1,000 × 1.05 = $1,050
Year 2: $1,050 × 1.05 = $1,102.50
... Year 10: $1,000 × 1.05¹⁰ = $1,628.89

The same money at simple interest would give you only $1,500. The extra $128.89 is compound interest at work.

Why Time Beats the Rate

Compounding is exponential, so its power accelerates. A modest return over three decades beats a high return over five years. Starting early is the single most effective lever you have — each early year gets to compound for all the years that follow.

The Rule of 72

Want a quick estimate of doubling time? Divide 72 by the annual rate. At 6%, money doubles in roughly 12 years (72 ÷ 6). At 9%, about 8 years.

Compounding Works Against You Too

Debt compounds just like savings. A credit card balance growing at a high annual rate can double quickly if you only make minimum payments — which is why paying down high-interest debt is usually the best "investment" you can make.

Try It Yourself

Play with the numbers on our Compound Interest Calculator — change the rate, term or contributions and watch the curve respond instantly.