Investing BasicsGlossary
Compound interest
Compound interest is interest paid on your principal and on interest already earned. Plain-English definition, a worked example and related terms.
Also called: compounding, interest on interest
Quick answer
Compound interest is interest paid on your original money (the principal) and on the interest that money has already earned, so each period's growth is calculated on a slightly bigger base.
What does compound interest mean?#
The SEC's Investor.gov glossary defines compound interest as interest paid on principal and on accumulated interest[1]. In everyday words: you earn interest on your interest. The opposite is simple interest, which is only ever calculated on the original amount.
A Federal Reserve Bank of St. Louis explainer describes it the same way — interest on your original principal plus on the interest your investment generates[2]. The effect is small in any single year and large over decades.
What does it look like with real numbers?#
Worked example
$1,000 at 6% a year for three years
Year one earns $60, so the balance is $1,060. Year two earns 6% of $1,060, which is $63.60. Year three earns $67.42 on $1,123.60. After three years the balance is $1,191.02 instead of the $1,180 simple interest would give.
| Year | Interest earned | Balance |
|---|---|---|
| 1 | $60.00 | $1,060.00 |
| 2 | $63.60 | $1,123.60 |
| 3 | $67.42 | $1,191.02 |
Figures computed in code from the stated inputs; rounded to the nearest cent or tenth.
Why does the difference grow over time?#
In the first years compound and simple interest look almost the same: after three years the gap in the example above is $11.02. The gap widens because every year adds interest on a bigger base. Over 30 years at the same 6%, $1,000 grows to about $5,743 with annual compounding versus $2,800 with simple interest. Fees and debt follow the same rule in reverse, which is why small yearly costs matter.
Where will you see this term?#
Savings accounts, certificates of deposit and bonds quote interest rates, and savings accounts and CDs also say how often interest compounds — for example yearly, monthly or daily. The SEC's compound interest calculator asks you to choose that frequency, from annually to daily[3]; more frequent compounding gives a slightly higher result at the same rate. With stocks and funds, people say returns "compound" when gains and dividends are reinvested, though those returns are not fixed.
For the full explanation, with a 30-year table and the effect of fees, read how compound interest works. To run your own numbers, use the compound growth calculator or the rule of 72 calculator.
Sources
Numbers in brackets in the text point here. Grade A = primary source (regulator, statistics agency, law or official document).
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