Compound interest is often referred to as “interest on interest” because it’s the interest earned on both the initial principal amount and the accumulated interest from previous periods. Imagine it like a snowball rolling downhill, getting bigger and bigger the further it goes.

1. Start with a principal amount: This is the initial amount of money you invest or borrow.
2. Earn interest on the principal: This is the basic interest you’d get if you used simple interest.
3. Add the interest to the principal: This creates a new, larger amount.
4. Earn interest on the new amount: This is where things get interesting! You’re now earning interest not just on the original principal, but also on the accumulated interest from the previous period.
5. Repeat steps 3 and 4: Over time, the interest you earn keeps growing at an accelerating rate, thanks to the power of compounding.

Here’s an example to illustrate:

• Let’s say you invest $1,000 at an annual interest rate of 5%.
• After one year, you’ll earn $50 in interest, bringing your total balance to $1,050.
• In the second year, you’ll earn interest not just on the original $1,000, but also on the $50 you earned in the first year. So, you’ll earn $52.50 in interest, bringing your total balance to $1,102.50.
• As you can see, the amount of interest you earn keeps growing each year, thanks to compounding.

The more frequently interest is compounded, the faster your money will grow. For example, if interest is compounded monthly instead of annually, you’ll earn even more interest.

Compound interest can be a powerful tool for growing your wealth over time. If you start investing early and let your money compound, you can accumulate a significant amount of money over the long term.

Here are some things to keep in mind about compound interest:

• The longer your investment horizon, the greater the impact of compounding.
• The higher the interest rate, the faster your money will grow.
• The more frequently interest is compounded, the better.