Understanding Compound Interest
Compound interest is often referred to as "interest on interest." Unlike simple interest, which only generates earnings on your original principal, compound interest reinvests your earnings so that your money grows exponentially rather than linearly.
The Compound Interest Formula
Where A = final amount, P = initial principal, r = annual interest rate (decimal), n = number of times compounded per year, and t = number of years.
Frequently Asked Questions
What is the difference between APR and APY?
Annual Percentage Rate (APR) reflects the simple annual rate without factoring in compounding periods. Annual Percentage Yield (APY) accounts for how frequently interest compounds throughout the year, giving you the actual effective annual return.
Why does starting early matter so much?
Because compounding growth is exponential, the final decade of a multi-decade horizon typically yields significantly more returns than the first decade combined. Starting 10 years earlier can more than double your final retirement nest egg.