Compound Interest

Compound interest is the interest that is earned on the principal of an investment, as well as any previously earned interest. This means that the more time an investment has to grow, the more it can earn in compound interest. Compound interest can be contrasted with simple interest, which is interest that is earned only on the principal of an investment.

Here is an example to illustrate the difference between compound and simple interest:

Imagine that you invest $1000 at a 5% annual interest rate. After one year, you will have earned $50 in simple interest (5% of $1000). If you leave the interest in the account, it will continue to grow, earning additional interest in the following year.

With compound interest, the interest that has been earned is added to the principal, so that the following year you will earn interest not just on the original $1000, but also on the $50 in interest that was earned in the first year. In this example, after two years with compound interest, you would have earned a total of $52.50 in interest (5% of $1050).

As you can see, compound interest can add up quickly over time, particularly if you are able to leave your investment to grow for a long period of time.