Definition
Compound interest is interest calculated on both the initial principal and all previously accumulated interest. Unlike simple interest (which only applies to the original amount), compound interest causes balances to grow exponentially over time. The more frequently interest compounds, the faster your balance grows.
Example
You invest $10,000 at 7% annual interest compounded monthly. After 1 year, your balance is $10,723 — not $10,700 as simple interest would give you. After 20 years with no additional contributions, that $10,000 grows to $40,388. The $30,388 of growth is entirely due to compound interest.
How It’s Calculated
A = P × (1 + r/n)(n×t), where A = final amount, P = principal, r = annual interest rate (decimal), n = compounding frequency per year, t = time in years. Monthly compounding: A = $10,000 × (1 + 0.07/12)(12×20) = $40,388.
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