Compound interest is the process by which interest earns interest. Rather than calculating returns only on your original principal, compound interest calculates returns on the principal plus all previously earned interest. Over time, this creates exponential rather than linear growth.

Simple vs. Compound Interest

With simple interest, you earn interest only on your principal. A $10,000 investment at 8% simple interest earns exactly $800 per year, every year — $8,000 total over 10 years.

With compound interest at the same rate, you earn $800 in year 1, but in year 2 you earn 8% on $10,800, not $10,000 — so you earn $864. Each year's base grows, and so does each year's interest. After 10 years, you'd have ~$21,589 — more than double your original investment.

The Formula

The compound interest formula is:

A = P(1 + r/n)^(nt)

A = Final amount
P = Principal (initial investment)
r = Annual interest rate (as a decimal)
n = Number of times interest compounds per year
t = Time in years

The Rule of 72

The Rule of 72 is a quick mental math shortcut to estimate how long it takes an investment to double. Divide 72 by your annual return rate:

At 6% return: 72 ÷ 6 = 12 years to double
At 8% return: 72 ÷ 8 = 9 years to double
At 12% return: 72 ÷ 12 = 6 years to double

Why Starting Early Matters More Than Amount

Consider two investors:

Investor A invests $5,000/year from age 25 to 35 (10 years, $50,000 total), then stops
Investor B invests $5,000/year from age 35 to 65 (30 years, $150,000 total)

Assuming 8% annual returns, Investor A ends up with more money at retirement — despite contributing only one-third as much. The early decade of compounding cannot be caught up by larger later contributions.

Maximizing Compound Growth

Start early: Time is the most powerful variable
Reinvest dividends: Don't take dividends as cash — let them compound
Minimize fees: A 1% annual fee sounds small but can consume 25% of your long-term wealth
Increase contributions over time: Regular increases to your monthly contributions dramatically accelerate final values
Use tax-advantaged accounts: IRAs and 401(k)s let compound growth occur without annual tax drag

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