What is Compound Interest?
When you deposit money in a bank, the bank pays you interest — a reward for letting them use your funds. There are two main ways interest can be calculated:
- Simple interest adds a fixed amount each period, calculated as a percentage of the original deposit only.
- Compound interest adds a percentage of the current balance each period — so your interest earns interest too.
This distinction might sound minor, but over long periods the difference is enormous due to exponential growth.
Example
Deposit \text{\}5000$ into two accounts, both offering 5% annual interest.
- Account A (simple interest): balance increases by \text{\}(0.05 \times 5000) = \text{$}250$ every year.
- Account B (compound interest): balance is multiplied by every year.
After 50 years:
Compound interest produces more than three times the balance of simple interest over the same period!
Compound Interest
Interest calculated on both the initial principal and the accumulated interest from previous periods. The balance grows by a fixed percentage of the current amount each compounding period.