Compound interest is often described as interest on interest. It is the reason small, regular savings can grow meaningfully over long periods — and why debt can snowball if it isn’t managed.
Simple vs. compound interest
With simple interest, you earn interest only on the original amount. With compound interest, the interest you earn is added to your balance, and future interest is calculated on the larger total.
An easy example
Suppose you save 1,000 at a hypothetical 5% annual rate, compounded yearly, and add nothing more:
| Year | Starting balance | Interest earned | Ending balance |
|---|---|---|---|
| 1 | 1,000.00 | 50.00 | 1,050.00 |
| 2 | 1,050.00 | 52.50 | 1,102.50 |
| 3 | 1,102.50 | 55.13 | 1,157.63 |
The interest grows each year even though you haven’t added money. Over decades, that effect becomes much larger.
The same force works against you in debt
Unpaid credit card balances can compound too, often at far higher rates than savings accounts pay. Paying more than the minimum reduces how much interest compounds on your balance.
Time matters most
Starting earlier generally matters more than finding the perfect rate, because compounding needs time to work.
Rates in this example are illustrative only. Real returns vary and investments can lose value.
