Calculate how your money grows with compound interest. See the power of compounding with different frequencies and contribution schedules.
What is Compound Interest?
Compound interest is interest calculated on the initial principal and accumulated interest from previous periods. Unlike simple interest (calculated only on principal), compound interest grows exponentially over time.
The Compound Interest Formula
A = P(1 + r/n)^(nt)
Where: A = Final amount, P = Principal, r = Annual interest rate, n = Compounding frequency per year, t = Time in years
Einstein's "8th Wonder"
Albert Einstein allegedly called compound interest "the eighth wonder of the world," saying "He who understands it, earns it; he who doesn't, pays it." This illustrates how powerful compounding can be for wealth building.
Example: $10,000 at 6% for 20 Years
- Compounded Annually: $32,071
- Compounded Monthly: $33,102
- Compounded Daily: $33,198
Notice how more frequent compounding increases returns, though the effect is relatively modest compared to the impact of time and rate.
Maximizing Compound Interest
Start Early
Time is the most powerful factor in compound interest. Starting 10 years earlier can double or triple your final amount, even with the same total contributions. Don't wait to start saving and investing.
Contribute Regularly
Regular contributions (dollar-cost averaging) amplify the effects of compounding. Even small monthly additions make a significant difference over decades.
Reinvest All Returns
Always reinvest dividends, interest, and capital gains rather than withdrawing them. This maximizes the compounding effect and accelerates growth.
Minimize Fees and Taxes
Fees and taxes reduce your effective return rate. Use low-fee index funds and tax-advantaged accounts (401k, IRA, Roth IRA) to maximize compound growth.
The Rule of 72
Quick way to estimate doubling time: 72 ÷ interest rate = years to double. For example, at 8% return, your money doubles in about 9 years (72 ÷ 8 = 9).
Frequently Asked Questions
What is compound interest?
Compound interest is interest calculated on both the initial principal and accumulated interest from previous periods. It grows exponentially rather than linearly, creating a snowball effect where your money grows faster over time.
How does compounding frequency affect growth?
More frequent compounding (daily vs annually) increases returns slightly. However, the effect is modest - the most important factors are the interest rate and time period. For example, $10,000 at 6% for 20 years grows to $32,071 (annual) vs $33,198 (daily), a difference of about 3.5%.
What's the difference between compound and simple interest?
Simple interest is calculated only on the principal amount (P × r × t). Compound interest is calculated on principal plus accumulated interest, leading to exponential growth. For $10,000 at 6% for 20 years: simple interest yields $22,000, while compound interest yields $32,071.
What's a good compound interest rate?
Depends on the investment: savings accounts offer 3-5%, bonds 4-6%, balanced portfolios 6-8%, and stock market averages 10% historically. Higher rates come with higher risk. Conservative estimates use 6-7% for long-term planning.
How long does it take to double my money?
Use the Rule of 72: divide 72 by your interest rate. At 6%, money doubles in 12 years (72 ÷ 6). At 8%, it doubles in 9 years. At 10%, 7.2 years. This is a quick approximation that's remarkably accurate.
Should I pay off debt or invest?
If debt interest exceeds investment returns, pay off debt first. For example, 18% credit card debt should be paid before investing for 8% returns. For low-interest debt (3-5% mortgage), you can invest simultaneously. Always get employer 401k match first - it's guaranteed returns.
Does inflation affect compound interest?
Yes. Inflation reduces purchasing power of returns. If you earn 7% but inflation is 3%, your "real return" is only 4%. This is why keeping money in low-interest accounts loses value over time - the interest doesn't keep pace with inflation.
Can I lose money with compound interest?
In savings accounts and CDs, no - your principal is guaranteed. In investments (stocks, bonds), yes - market losses can reduce your balance. However, historically, diversified stock portfolios have positive returns over long periods (10+ years).
