How compound interest grows your savings

Interest on interest

With simple interest you earn a fixed amount each year on the original deposit. With compound interest, each period’s interest is added to the balance, and the next period’s interest is calculated on the larger total. The balance therefore grows faster each year.

The effect looks small at first and becomes large with time. Deposit 1,000 at 5 % a year: after ten years simple interest gives 1,500, while compounding gives about 1,629. After thirty years the figures are 2,500 and about 4,322.

Frequency matters less than rate and time

Interest can be compounded yearly, monthly or daily. More frequent compounding helps, but with diminishing returns. At 5 % a year, monthly compounding gives an effective annual rate of about 5.116 % and daily compounding about 5.127 %. When comparing savings products, compare the effective annual rate or the APY rather than the stated rate.

Far more powerful are the two things you control: the rate you earn and how long you leave the money untouched. Starting ten years earlier usually beats saving noticeably more later.

Regular contributions

Adding a fixed amount every month makes compounding work on a growing base. Each deposit earns interest for the remaining time, so early deposits do most of the work. The Compound Interest Calculator lets you set an initial deposit, a regular contribution and the compounding frequency, and shows how much of the final balance is interest.

The Rule of 72

To estimate how long money takes to double, divide 72 by the annual rate in percent. At 6 % it takes about 12 years; at 9 % about 8 years. The rule is most accurate around 8 % and works in reverse to find the rate needed to double in a given time.

Remember that the figures assume a constant rate with no fees, taxes or withdrawals, and that inflation reduces what the money can buy. Real returns vary, so use the results as a planning guide rather than a promise.