What is compound interest? A simple explanation with examples
Compound interest is when your money earns money, and then that new money earns money too. It's the main reason small amounts can grow into big amounts over time.
Key points
- With compound interest, you earn returns on your returns.
- Time matters more than almost anything else.
- $10,000 growing 8% a year becomes about $100,000 in 30 years.
A simple example
You put $1,000 in an account that grows 10% a year.
- Year 1: you earn $100. Now you have $1,100.
- Year 2: you earn 10% of $1,100, which is $110. Now you have $1,210.
- Year 3: you earn $121. Now you have $1,331.
You didn't add any money. But each year's gain got bigger, because it was based on a bigger number.
Simple interest vs compound interest
With simple interest, you only earn on the money you first put in. With compound interest, you also earn on your past gains. Here's $10,000 at 8% for 30 years:
| Type | After 30 years |
|---|---|
| Simple interest | $34,000 |
| Compound interest | $100,627 |
Same money, same rate. Compounding ends up with almost three times as much.
How it grows over time
Here's $10,000 left alone at 8% a year:
| Years | Balance |
|---|---|
| 5 | $14,693 |
| 10 | $21,589 |
| 20 | $46,610 |
| 30 | $100,627 |
| 40 | $217,245 |
Notice how the jumps get bigger. From year 30 to year 40, it grows by more than $116,000. In the first 10 years, it grew by about $11,600.
Where you get compound growth
- Savings accounts and CDs: interest is added to your balance, then earns interest too.
- Index funds and stocks: growth and reinvested dividends build on each other. This isn't a fixed rate like a bank, and it can go down in some years.
- Debt: compounding works against you on credit cards. Unpaid interest gets added to what you owe.
How to make compounding work for you
- Start early. Even small amounts get decades to grow.
- Add money often. Each paycheck gives compounding more to work with.
- Reinvest dividends. Let your earnings buy more shares.
- Keep fees low. Fees shrink your growth every year.
- Be patient. The biggest gains come near the end.
Watch compound interest grow your own paycheck deposits.
Open the calculatorQuick answers
What is compound interest in simple words?
It's earning money on your money and also on the money it already earned. Your gains start making their own gains.
How often does interest compound?
It depends. Many savings accounts compound daily or monthly. With investments, growth builds whenever prices rise and dividends are reinvested.
Is compound interest good or bad?
It's good when you're saving or investing. It's bad when you owe money, like on a credit card, because your debt grows faster.
How long does it take to double my money?
Divide 72 by your yearly rate. At 8%, money doubles in about 9 years. This is called the Rule of 72.
Sources
Keep learning
- The Rule of 72: how fast will my money double?
- How much will $200 a paycheck grow?
- Should I reinvest dividends?
This article is for learning only. It is not financial, tax or legal advice. Example returns are not promises. Talk to a licensed professional about your own situation.