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Quick Definition
Compound interest is the process of earning interest not only on the original amount of money you invest or borrow (the principal), but also on the interest that builds up over time. This effect, often called “interest on interest,” makes money grow faster than with simple interest.
Unlike simple interest, it grows faster because each interest payment is added back to the balance. This makes it powerful for savings and costly for debt.
👉 Example: If you invest $100 at 5% annual compound interest, after one year you’ll have $105. In year two, you earn interest on $105, giving you $110.25. That’s the power of compounding.
Quick Navigation
- Quick Definition
- Compound Interest Formula
- Worked Example – Compound Interest
- Why Compound Interest Matters
- Related Terms
- Disclaimer – Educational Use Only
Compound Interest Formula
Where:
- 𝐴 = the final amount after interest
- 𝑃 = the principal (initial investment or loan)
- 𝑟 = annual interest rate (decimal form)
- 𝑛 = number of compounding periods per year
- 𝑡 = time in years
Worked Example – Compound Interest
If you invest $1,000 at a 5% annual interest rate, compounded once per year, after 10 years the calculation looks like this:
= $1,628.89
This shows how compounding accelerates growth compared to simple interest, which would only give you $1,500 over the same period.
Try it Yourself
Term Deposit / Certificate of Deposit Calculator
Explore the effect of pure compounding without extra contributions.
Why Compound Interest Matters
Compound growth is powerful. It helps savings and investments expand more quickly; however, it can also make debt more expensive if left unpaid. Therefore, understanding how it works is essential for smart financial planning.
If you invest $1,000 at 5% compounded annually, after 10 years you’ll have about $1,628.89. This shows how interest earns interest over time.
It accelerates savings growth, but it can also increase the cost of borrowing.
Use the formula \(( A = P(1 + r/n)^{nt} )\)
Related Terms
- Simple Interest
- Annual Percentage Yield (APY)
- Present Value
Related Tools
- Regular Savings Calculator – see how compounding works with regular contributions
- Home Loan Calculator – understand how compounding affects repayments
📖 Browse more terms in our Financial Dictionary.
Disclaimer – Educational Use Only
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