Compound Interest

Definition

Compound interest is when your earnings generate their own earnings. If you earn $100 in interest, next year you earn interest on that $100 too. This creates exponential growth over time, not just linear growth. It's often called the eighth wonder of the world because it's so powerful, especially over decades. The longer you let it work, the more dramatic the effect.

Why it matters

This is why starting to save early is so much more valuable than trying to catch up later. Someone who invests $5,000 per year from age 25 to 35 (10 years) ends up with more at retirement than someone who invests $5,000 per year from 35 to 65 (30 years), even though the second person put in three times as much money. Those extra decades of compounding are worth more than the extra contributions. High-interest credit card debt is compound interest working against you, which is why it spirals so fast.

Quick example

You invest $10,000 at 8% annual return. Year 1, you earn $800 (now you have $10,800). Year 2, you earn $864 (8% of $10,800, not just the original). By year 30, you have $100,626 from that single $10,000 investment. The last 10 years added about $30,000 of growth. That's compound interest doing the heavy lifting.

The bottom line

Knowing what Compound Interest means helps you make better day-to-day money decisions. It makes rates, account options, and tradeoffs easier to compare.