Albert Einstein reportedly called compound interest the "eighth wonder of the world", saying: "He who understands it, earns it; he who doesn't, pays it."
Whether or not Einstein actually said this, the sentiment is absolutely true. Compound interest is the single most powerful force in personal finance — and understanding it can change your financial future.
Simple Interest vs. Compound Interest
Let's start with the basics. There are two types of interest:
- Simple Interest: Interest is calculated only on the original principal
- Compound Interest: Interest is calculated on the principal PLUS all accumulated interest
Here's an example with $10,000 at 10% annual interest over 5 years:
| Year | Simple Interest | Compound Interest |
|---|---|---|
| 1 | $11,000 | $11,000 |
| 2 | $12,000 | $12,100 |
| 3 | $13,000 | $13,310 |
| 4 | $14,000 | $14,641 |
| 5 | $15,000 | $16,105 |
With simple interest, you earn $5,000 in 5 years. With compound interest, you earn $6,105 — an extra $1,105 just by earning interest on your interest!
The Compound Interest Formula
- A = Final amount (principal + interest)
- P = Principal (initial investment)
- r = Annual interest rate (as a decimal)
- n = Number of times interest compounds per year
- t = Time in years
The Rule of 72
Want a quick way to estimate how long it takes to double your money? Use the Rule of 72:
Examples:
- At 6% interest: 72 ÷ 6 = 12 years to double
- At 8% interest: 72 ÷ 8 = 9 years to double
- At 12% interest: 72 ÷ 12 = 6 years to double
See Your Money Grow
Calculate exactly how much your investment will grow with compound interest.
Open Compound Interest CalculatorWhy Compounding Frequency Matters
The more frequently interest compounds, the more you earn. Here's $10,000 at 10% for 10 years with different compounding frequencies:
| Frequency | Final Amount | Interest Earned |
|---|---|---|
| Annually | $25,937 | $15,937 |
| Quarterly | $26,851 | $16,851 |
| Monthly | $27,070 | $17,070 |
| Daily | $27,183 | $17,183 |
The Power of Starting Early
Time is the most important factor in compound interest. Consider two investors:
- Investor A: Invests $5,000/year from age 25 to 35 (10 years, then stops)
- Investor B: Invests $5,000/year from age 35 to 65 (30 years)
At age 65, assuming 8% annual returns:
- Investor A: $787,000 (invested only $50,000)
- Investor B: $611,000 (invested $150,000)
Investor A invested three times less but ended up with more money — all because of the extra 10 years of compounding!
Key Takeaways
- Compound interest earns interest on your interest
- Use the Rule of 72 to estimate doubling time
- More frequent compounding = more growth
- Start investing early — time is your biggest advantage
- Avoid high-interest debt — compound interest works against you
Ready to see how your savings will grow? Try our Compound Interest Calculator to model different scenarios.