How Compound Interest Works
Formula: A = P(1 + r/n)^(nt)
Where:
- A = Final amount
- P = Principal (initial investment)
- r = Annual interest rate (as decimal)
- n = Compounding frequency per year
- t = Time in years
Key Insight: Compound interest is "interest on interest." The more frequently it compounds, the more you earn.
Frequently Asked Questions
What's the difference between simple and compound interest?
Simple interest is calculated only on the principal. Compound interest is calculated on the principal plus accumulated interest, so it grows faster.
Does compounding frequency matter?
Yes. More frequent compounding (daily vs annually) means higher returns. Daily compounding earns slightly more than annual compounding.
How long does it take to double my money?
Use the "Rule of 72": Divide 72 by your interest rate. For 6% interest, it takes roughly 72รท6 = 12 years to double.