What is compound interest?
Compound interest is interest that earns interest. Instead of paying out only on the money you originally set aside, each round of interest is added back to your balance — and the next round is then calculated on that larger total. People often call this effect “interest on interest,” and it is the reason a modest sum left to grow can snowball into a much bigger one over time.
Simple interest, by contrast, is always worked out on the original amount alone. Over a year or two the gap is small, but across decades compounding pulls steadily ahead.
Making compound interest work for you
Three levers make the biggest difference. The first is time: the earlier you start, the more compounding cycles your money goes through. The second is regular contributions — adding a little on a steady schedule gives compounding more to work with. The third is how often interest is compounded; daily or monthly compounding edges out annual compounding for the same headline rate.
Where to invest for compound interest
Savings accounts, certificates of deposit, bonds, and broad market funds are all common places where returns can compound. Each carries its own balance of risk, return, and access to your money. This tool is for illustration only — for decisions about your own situation, speak with a qualified financial advisor.
How is compound interest calculated?
The standard formula is A = P(1 + r/n)nt, where A is the final amount, P is the principal, r is the annual rate as a decimal, n is the number of times interest compounds per year, and t is the number of years.
As a worked example, $1,000 at 5% compounded monthly for one year gives 1000 × (1 + 0.05/12)12 ≈ $1,051.16 — about 16 cents more than the $1,051 you would get from simple interest, thanks to compounding.
Example: $10,000 invested for 20 years at 5%
The table below is produced by the same engine that powers the calculator above, using monthly compounding. Notice how the yearly interest figure keeps rising even though the rate never changes — that is compounding at work.
| Year | Interest | Balance |
|---|---|---|
| 1 | $511.62 | $10,511.62 |
| 2 | $537.79 | $11,049.41 |
| 3 | $565.31 | $11,614.72 |
| 4 | $594.23 | $12,208.95 |
| 5 | $624.63 | $12,833.59 |
| 6 | $656.59 | $13,490.18 |
| 7 | $690.18 | $14,180.36 |
| 8 | $725.49 | $14,905.85 |
| 9 | $762.61 | $15,668.47 |
| 10 | $801.63 | $16,470.09 |
| 11 | $842.64 | $17,312.74 |
| 12 | $885.75 | $18,198.49 |
| 13 | $931.07 | $19,129.56 |
| 14 | $978.70 | $20,108.26 |
| 15 | $1,028.78 | $21,137.04 |
| 16 | $1,081.41 | $22,218.45 |
| 17 | $1,136.74 | $23,355.19 |
| 18 | $1,194.90 | $24,550.08 |
| 19 | $1,256.03 | $25,806.11 |
| 20 | $1,320.29 | $27,126.40 |
Compounding with additional deposits
Adding money on a regular schedule changes the picture dramatically. Each deposit begins compounding from the moment it lands, so a steady monthly contribution over many years can end up contributing more growth than the original lump sum. Try switching the contributions control above to Deposits to see the effect on your own numbers.
Frequently asked questions
When is interest compounded?+
It depends on the account or investment. Compounding can happen daily, monthly, quarterly, or yearly. The more often interest is added to your balance, the more often that interest itself starts earning — which is why the compounding frequency matters.
Can I include regular withdrawals?+
Yes. Switch the contributions control to Withdrawals (or Both) and choose either a fixed amount or a percentage of the interest earned. The schedule then subtracts those amounts at the frequency and timing you select.
What is the effective annual interest rate (APY)?+
The effective annual rate, or APY, is the true yearly return once compounding is taken into account. A 5% nominal rate compounded monthly works out to about 5.12% effective, because each month’s interest goes on to earn interest of its own.
What is the difference between RoR and TWR?+
Rate of Return (RoR) simply compares your final balance with your starting balance. Time-Weighted Return (TWR) strips out the effect of money you added or removed along the way, so it reflects how the investment itself performed rather than your contribution timing. We show TWR automatically whenever you include deposits or withdrawals.
A final word
Compound interest rewards patience more than timing. The figures here assume a constant rate and the exact contributions you enter, which real-world investments rarely guarantee. Treat the results as a guide for understanding the mechanics — not as a forecast or as financial advice.