What Is Compound Interest?

Compound interest is interest calculated on the initial principal and also on the accumulated interest from previous periods. Unlike simple interest, which is only calculated on the original principal, compound interest grows exponentially over time because each period's interest becomes part of the next period's principal. This is why compound interest is often called the eighth wonder of the world.

How Compound Interest Works

The compound interest formula is A = P(1 + r/n)^(nt), where A is the final amount, P is the principal (initial investment), r is the annual interest rate (as a decimal), n is the number of times interest compounds per year, and t is the number of years. For example, $10,000 at 5% annual interest compounded monthly for 10 years grows to $16,470.09 — earning $6,470.09 in interest alone.

Simple vs Compound Interest

With simple interest on $10,000 at 5% for 10 years, you would earn $5,000 in interest (10,000 x 0.05 x 10). With compound interest (compounded monthly), you earn $6,470.09 — nearly 30% more. The difference grows dramatically over longer time periods and with higher interest rates.

Why Compound Interest Matters

Compound interest affects both savers and borrowers. For savers and investors, it means your money grows faster over time, making early investment extremely powerful. For borrowers, it means debt can grow quickly if you only make minimum payments. Understanding compound interest is essential for making informed financial decisions about savings accounts, mortgages, student loans, and investments.

Try Tool Elixir Compound Interest Calculator

Tool Elixir provides a free compound interest calculator that shows you exactly how your money grows over time. Enter your principal, interest rate, compounding frequency, and time period to see detailed year-by-year breakdowns. The calculation happens entirely in your browser.