Understanding Compound Interest
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Unlike simple interest, which only earns on the original amount, compound interest creates a snowball effect where your money grows exponentially over time.
The Compound Interest Formula
A = P(1 + r/n)^(nt) where A is the final amount, P is principal, r is annual rate, n is compounding frequency per year, and t is years. More frequent compounding produces higher returns because interest starts earning interest sooner.
How Compounding Frequency Affects Returns
Daily compounding earns more than monthly, which earns more than annual. On $10,000 at 6% for 10 years: annual gives $17,908, monthly gives $18,194, and daily gives $18,220. The differences are small but compound over time.