Compound Interest
Definition
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods, creating exponential growth over time.
Explanation
Compound interest is often called the eighth wonder of the world because of its powerful ability to grow wealth. Unlike simple interest, it earns interest on previously earned interest. The frequency of compounding matters — daily generates more than monthly, which generates more than annual compounding.
Time is the most critical factor. Starting just a few years earlier can result in dramatically more wealth due to the exponential nature of compounding. Compound interest works for you when saving and investing, but against you on credit cards and loans.
Example
Investing $10,000 at 7% compounded monthly grows to $19,671 after 10 years, $38,697 after 20 years, and $76,123 after 30 years.