What is the difference between simple and compound interest?
Simple interest is calculated only on the original principal: Interest = Principal × Rate × Time. Compound interest is calculated on the principal plus any interest already earned, so growth accelerates over time. $10,000 at 5% for 20 years earns $10,000 in simple interest (total $20,000), but compounded annually it grows to about $26,533 — nearly $6,500 more — purely from interest earning interest.
How does compounding frequency affect returns?
More frequent compounding produces slightly higher returns because interest is added to the balance — and starts earning its own interest — sooner. $10,000 at 6% for 10 years grows to $17,908 compounded annually, $17,959 compounded monthly, and $17,966 compounded daily. The difference shrinks as the rate gets lower, but it always favors more frequent compounding.
What is the Rule of 72 and how does it relate to compound interest?
The Rule of 72 is a quick mental shortcut to estimate how long it takes an investment to double: divide 72 by the annual interest rate. At 6% annual interest, money doubles in about 72 ÷ 6 = 12 years. At 9%, about 8 years. It is an approximation that works best for rates between roughly 6% and 10%.
How do regular contributions change compound interest growth?
Adding a fixed contribution each compounding period dramatically accelerates growth because each new contribution also starts compounding immediately. $10,000 invested at 7% for 30 years grows to about $76,123 with no further contributions, but adding just $200/month over the same period grows the balance to roughly $312,000 — showing how consistent contributions can matter more than the initial lump sum.
Why do savings accounts and credit cards both use compound interest?
Compound interest works in your favor when you are earning it (savings, investments) and against you when you are paying it (credit cards, loans). A savings account compounding interest grows your balance faster over time; a credit card compounding interest daily on an unpaid balance grows your debt faster. Understanding this is why paying off high-interest debt is often a better "investment" than a low-interest savings account.