What Is Compound Interest?
Compound interest is the process of earning returns on your returns. When interest is added to your principal, the next period's interest is calculated on the new, larger balance, so growth accelerates over time instead of staying flat.
This contrasts with simple interest, which is calculated only on the original principal. On a $10,000 deposit at 5%, simple interest pays $500 every year forever, while compound interest pays $500 in year one, $525 in year two, $551 in year three, and steadily more each year after that.
How Compounding Grows Money
The core formula is future value equals principal times (1 + r)^n, where r is the periodic rate and n is the number of periods. A $10,000 investment growing at 7% annually becomes about $19,700 in 10 years, $38,700 in 20 years, and $76,100 in 30 years, with each decade adding more dollars than the last.
A useful mental shortcut is the Rule of 72: divide 72 by your annual return to estimate how many years it takes money to double. At 8%, money doubles roughly every 9 years, so a 22-year-old's dollar can double four to five times before retirement.
Why Starting Early Beats Saving More
Time in the market is the most powerful input to the compounding equation, more powerful than the amount saved. An analyst who invests $10,000 a year from age 22 to 32 and then stops, contributing $100,000 total, ends up with more at age 60 than a peer who invests $10,000 a year from 32 to 60 and contributes $280,000, assuming the same 7% return.
This is why capturing your 401(k) match and funding a Roth IRA in your first years on the desk matters so much. Every year of delay removes the final and largest doubling from your compounding runway.
Compounding Works Against You Too
The same math applies to debt. Credit card balances compounding at a 24% APR double in roughly three years if unpaid, which is why carrying revolving debt while investing rarely makes sense.
Fees compound negatively as well. A 1% annual fund fee sounds small, but over 30 years it can consume roughly a quarter of a portfolio's ending value compared to a low-cost index fund, which is why cost discipline is a core habit of professional investors.
