fundamentals

compound interest

Interest calculated on both the initial principal and the accumulated interest from previous periods.

Example

“Thanks to compound interest, her $10,000 investment grew to $40,000 over 20 years.”

Memory Tip

Compound means built on top of itself. Interest on interest — the snowball effect of money.

Why It Matters

Compound interest is the most powerful force in personal finance. Starting to invest at 25 versus 35 can literally double your retirement wealth not because you invest twice as much but because compounding has 10 more years to work. Time in the market is the single most important factor in long-term wealth building.

Common Misconception

Many people think the benefit of compounding is linear meaning an extra year of investing always adds the same amount. The opposite is true. Compounding is exponential so later years produce dramatically more growth than earlier ones. The last decade before retirement can generate more wealth than the first two decades combined.

In Practice

Invest $5,000 at age 25 at 8% annual return. By 65 it grows to $108,000 without adding another dollar. Start the same investment at 35 and it grows to only $50,000. The 10-year head start added $58,000. This is why financial advisors are so emphatic about starting early even with small amounts.

Etymology

Compound (combined) + interest — interest that compounds (builds on itself).

Common Misspellings

compund interestcompound intrestcompond interest

More in fundamentals

Other fundamentals terms you should know

assetAnything of value owned by a person or company that can be c…capitalWealth in the form of money or assets used to start or expan…cash flowThe net amount of cash moving in and out of a business or pe…creditThe ability to borrow money or access goods and services wit…debtMoney borrowed by one party from another that must be repaid…equityThe value of ownership in an asset or company after all debt…