What is Compound Interest?
Compound interest is interest calculated on the initial principal and also on the accumulated interest from previous periods. This means your money grows exponentially over time, especially when you make periodic contributions. Albert Einstein reportedly called it "the eighth wonder of the world."
Compound Interest Formula
A = P × (1 + r/n)^(n×t) + PMT × [((1 + r/n)^(n×t) - 1) / (r/n)]
- A = Final balance
- P = Initial principal
- r = Annual interest rate (decimal)
- n = Number of periods per year
- t = Time in years
- PMT = Periodic contribution
Practical Example
Suppose you invest $10,000 at 7% annual rate for 20 years adding $200/month:
- Initial capital: $10,000
- Total contributed: $10,000 + ($200 × 240 months) = $58,000
- Estimated final balance: ~$107,000
- Interest earned: ~$49,000 (almost as much as you contributed!)
Want to see if it's better to pay off debt first? Try our Invest vs Pay Debt calculator.
Frequently Asked Questions
What's the difference between contributing at the beginning or end of the period?
Contributing at the beginning means your money earns interest for the entire period, while contributing at the end only earns interest starting from the next period. Contributing at the beginning maximizes your earnings.
How can I maximize my earnings?
To maximize your earnings: invest early, make regular contributions, choose a competitive interest rate, and let it grow for as long as possible.
What is the Rule of 72?
Divide 72 by the annual interest rate to get roughly the years needed to double your investment. At 7% annual: 72 ÷ 7 ≈ 10 years to double.
How much should I save monthly for retirement?
The general rule is to save at least 10-15% of your gross income. The earlier you start, the less you need to save each month thanks to compound interest.
How often should interest be compounded?
Monthly compounding is most common in financial products. The more frequent the compounding, the higher the result. The difference between monthly and annual compounding can be significant over long periods.
Also see: Loan Simulator · Invest vs Pay Debt