Compound interest is often described as 'interest on interest' — when the returns on your money generate their own returns. Over long periods, this creates exponential growth that can turn modest, consistent contributions into significant sums. Understanding it is one of the most important foundations of personal finance.
With simple interest, you earn a return only on your original principal. If you invest $1,000 at 5% simple interest, you earn $50 every year — always based on the original $1,000. With compound interest, your $50 gain gets added to the balance. Next year, you earn 5% on $1,050. The year after, on $1,102.50. The base keeps growing.
Compounding can happen daily, monthly, quarterly, or annually. The more frequently it compounds, the faster your money grows. Most investment accounts compound either daily or monthly. Even annual compounding, however, produces dramatic results over long time horizons.
The Rule of 72 is a quick mental math shortcut: divide 72 by your annual rate of return to estimate how many years it takes to double your money. At a 6% annual return, your money roughly doubles every 12 years (72 ÷ 6 = 12). At 9%, it doubles roughly every 8 years.
Two investors both invest $200 per month at a 7% annual return. Investor A starts at age 25 and stops at 35 — 10 years of contributions. Investor B starts at 35 and keeps going until 65 — 30 years of contributions. Despite investing three times less money, Investor A often ends up with a larger balance at retirement due to extra decades of compounding. This is why time in the market is often cited as the key variable.
Yes. High-yield savings accounts compound your interest over time. While savings account rates are typically lower than investment returns, the same principle applies.
Absolutely. Compound interest is also how credit card debt grows. If you carry a balance at 20% APR and only make minimum payments, the interest compounds and the debt grows faster than you pay it down.
CAGR is the rate at which an investment grows on a year-over-year basis, assuming profits are reinvested. It's often used to describe how an investment or index performed over a multi-year period.
Educational content only. MyMoneyStep does not provide investment advice. All figures are illustrative.