What is compound interest?

Compound interest refers to the method of calculating interest where the interest earned is added to the principal amount, meaning that future interest calculations are based not only on the original principal but also on the accumulated interest from prior periods. This results in interest being calculated on a growing sum over time, which can significantly increase the overall amount accrued compared to simple interest, where calculations are based solely on the original principal.

This concept highlights the power of compounding, especially over longer periods, as it allows the investment or loan to grow exponentially as opposed to linearly. Understanding compound interest is crucial for various financial planning aspects, including savings and investments, as well as managing loans. It illustrates the benefits of reinvesting earnings or the consequences of accruing interest on debts.