Compounding Frequency
Definition
Compounding frequency is how often interest is calculated and added to the principal balance, affecting how quickly investments grow.
Explanation
Common compounding frequencies include daily, monthly, quarterly, semi-annually, and annually. More frequent compounding generates more total interest because interest is earned on interest more often. For example, $10,000 at 5% APY for 10 years: daily compounding yields $16,489, annual compounding yields $16,289.
The difference between compounding frequencies narrows as frequency increases — daily compounding is only marginally better than monthly, but both are significantly better than annual.
Example
$10,000 at 5% for 10 years: annually compounded = $16,289, monthly = $16,470, daily = $16,489. The difference grows with larger amounts and longer timeframes.