What Is Compound Interest?

Compound interest is interest earned on both your original money and on the interest it has already earned. Over time this "interest on interest" makes savings and investments grow faster and faster, which is why starting early matters so much. This is educational, not financial or investment advice.

Simple vs compound interest

With simple interest, only your starting sum earns. With compound interest, last year's interest also earns interest this year, so the balance grows by a larger amount each period.

A worked example

Say you invest $1,000 and it grows at a hypothetical 8 percent a year (an illustration, not a projected return). After year 1 you have $1,080. In year 2 you earn 8 percent on $1,080, not $1,000 — so you gain $86.40, not $80. Each year the gain is bigger than the last. Our compound interest calculator lets you try your own numbers.

Why time is the biggest lever

The longer money compounds, the more dramatic the effect, because the "interest on interest" has more cycles to build. This is why the same amount invested earlier can end up far larger than a bigger amount invested later, and why long-horizon investing leans on it so heavily.

Compounding in investing

In investing, compounding shows up when you reinvest returns — for example reinvesting dividends to buy more shares, which then produce their own returns. Investing a fixed amount regularly through dollar-cost averaging feeds the same engine.

The flip side

Compounding works against you on debt. Interest on a credit-card balance compounds too, so an unpaid balance grows the same accelerating way — which is why high-interest debt is usually cleared before investing.

Takeaway

Compound interest is interest on your interest, and it turns time into your biggest advantage. Start early, reinvest returns, and be just as wary of it working against you on debt.

Educational only — not financial or investment advice; investing carries a real risk of loss and returns are never guaranteed.