Compound Interest

What Is It

Compound interest is interest calculated on both your original balance and whatever interest that balance has already earned. Simple interest only ever pays you on the amount you put in; compound interest pays you on the amount you put in, plus every dollar of growth that's accumulated so far. Each period's earnings become part of next period's base — which is why the growth curve isn't a straight line, it bends upward over time.

Why It Matters

The bend in that curve is doing most of the work. In the early years, compounding looks almost identical to simple growth — the difference is small because there isn't much accumulated interest yet to earn interest on. Given enough time, that gap widens dramatically, which is why the single biggest lever in compound growth is usually time in the market, not squeezing out an extra point or two of return. A account that grows at a fixed rate has a directly related doubling time, which is exactly what the Rule of 72 approximates without needing the full formula.

It's also worth separating the rate you're quoted from the rate you actually keep. A 7% return sounds the same whether inflation is running at 2% or 6%, but it isn't — see Real vs. Nominal Returns for how that difference is measured. For stock market returns specifically, that quoted rate usually blends two different things — price growth and dividends — and only the price piece compounds automatically unless the dividends are reinvested too; see Price Return vs. Total Return for how that split changes the math.

Quick Example

Investing $300 a month at a 7% annual return, compounded monthly, for 20 years grows to roughly $156,000. Total money actually contributed over those 20 years: $72,000. The other $84,000 — more than half the final balance — is growth that compounding generated on its own, without another dollar of new contributions.

Try It Yourself

Plug in your own contribution amount, rate, and timeline to see how the growth curve bends for your numbers.

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