How Compound Interest Works
Compound interest is the process of earning interest on both your original principal and the interest you have already accumulated. This creates a snowball effect — the longer you invest, the faster your balance grows.
The Power of Time
Consider two investors: Alice starts investing $5,000 per year at age 25 and stops at 35 (10 years, $50,000 total). Bob starts at 35 and invests until 65 (30 years, $150,000 total). Assuming a 7% annual return, Alice ends up with more money at retirement — despite contributing three times less — because her money had more time to compound.
Compounding Frequency Matters
The more frequently interest compounds, the more you earn. Daily compounding produces slightly higher returns than monthly, which beats quarterly, which beats annual. For most savings accounts and investments, monthly compounding is standard.
The Rule of 72
A quick mental math shortcut: divide 72 by your annual interest rate to estimate how many years it takes to double your money. At 7%, your money doubles roughly every 10.3 years (72 ÷ 7 = 10.3). Use our Rule of 72 Calculator for a precise estimate.