When it comes to building wealth, compound interest is the most powerful tool you have. Albert Einstein famously called it the "eighth wonder of the world."
But how exactly does it work?
In this guide, we'll break down the math behind compound interest in plain English. Before we dive into the details, you can see the math in action for yourself. Use our **Free Compound Interest Calculator** to instantly project your wealth. It's 100% free, instant, and requires no signup.
Let's look at exactly how this financial superpower works.
What is Compound Interest?
At its core, compound interest is the interest you earn on your interest.
When you put money in a savings account or investment portfolio, it earns interest. If you leave that interest in the account, the next time interest is calculated, it's based on a larger amount: your original money plus the interest you already earned.
This creates a snowball effect. Over time, your money grows at an accelerating rate.
Simple Interest vs. Compound Interest
To understand compound interest, it helps to compare it to simple interest.
Simple interest is calculated only on the initial amount of money you invest (the principal).
Compound interest is calculated on the principal plus all the accumulated interest from previous periods.
Here is a quick comparison of what happens if you invest $10,000 at a 5% annual return for 10 years without adding any more money: