How Compound Interest Works (With Examples)
5 min read · Last reviewed July 1, 2026
Compound interest is often called the most powerful force in finance, and the maths is simpler than its reputation suggests. It's the reason a modest amount saved early can outgrow a much larger amount saved later.
Here's how it actually works, why time is the secret ingredient, and a shortcut for estimating growth in your head.
Interest on interest
With simple interest, you earn the same amount every year — interest only on your original deposit. With compound interest, each period's interest is added to the balance, so the next period earns interest on a bigger number. That 'interest on interest' is what makes the balance curve upward instead of rising in a straight line.
The formula
For a lump sum: A = P(1 + r/n)^(nt), where P is the principal, r the annual rate as a decimal, n how many times it compounds per year, and t the number of years.
You rarely need to compute this by hand — the point is to notice that t (time) sits in the exponent. That's why time matters so much: it multiplies, it doesn't just add.
Why starting early beats saving more
Because the later years do the heaviest lifting, someone who invests for 30 years usually ends up ahead of someone who invests more money but only for 15 years. The extra decade of compounding is worth more than the extra contributions.
The practical takeaway: start as early as you can, even with small amounts, and let time do the work.
The Rule of 72
A handy shortcut: divide 72 by your annual interest rate to estimate how many years it takes your money to double. At 8%, that's 72 ÷ 8 = about 9 years. At 6%, about 12 years. It's an approximation, but a good one for seeing the power of compounding quickly.
Frequently asked questions
▶What is compound interest in simple terms?
Interest earned on both your original money and on the interest it has already earned. Over time this 'interest on interest' makes your balance grow faster and faster.
▶How often should interest compound?
More frequent compounding (daily or monthly) earns slightly more than annual, but the difference is small. The rate and how long you stay invested matter far more.
Try the calculators
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