Compound Interest
Interest calculated on both the initial principal and all previously accumulated interest, causing wealth to grow exponentially over time.
Compound interest is often called the eighth wonder of the world. Unlike simple interest (calculated only on the principal), compound interest earns returns on your returns, creating exponential growth over time.
The Math
A = P(1 + r/n)^(nt) where P = principal, r = annual rate, n = compounding frequency, t = years. $10,000 at 8% compounded annually becomes $46,610 in 20 years — without adding a single dollar.
Maximizing Compound Interest
- Start investing as early as possible — time is the biggest factor
- Reinvest dividends and interest automatically
- Keep fees low (they compound against you)
- Stay consistent with regular contributions
FAQ
How powerful is compound interest?
Extremely. Starting at age 25 investing $300/month at 8% yields about $1 million by 65. Waiting until 35 to start the same plan yields only about $440,000 — less than half.
Does compound interest work on stocks?
Yes, when you reinvest dividends and let capital gains accumulate. Index funds and ETFs automatically compound returns. The S&P 500 has compounded at roughly 10% annually over decades.