How Compound Interest Works
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 earnings generate their own earnings. Albert Einstein reportedly called it the eighth wonder of the world.
The Formula
Where:
A = Final amount
P = Initial principal (starting amount)
r = Annual interest rate (decimal)
n = Number of times interest compounds per year
t = Number of years
PMT = Monthly contribution amount
Why Starting Early Matters
Consider two investors: one starts at age 25 investing $500/month and stops at 35 (10 years, $60,000 total). The other starts at 35 and invests $500/month until 65 (30 years, $180,000 total). At a 7% return, the early starter ends up with more money at 65 despite investing a third as much. This is the compounding advantage — time is the most powerful variable in the equation.
Compound Frequency
More frequent compounding generates slightly more interest. Monthly compounding (the most common for savings accounts and investments) produces more than annual compounding. However, the difference between monthly and daily compounding is minimal. The interest rate and time period have far greater impact than compounding frequency.
Frequently Asked Questions
What is a realistic rate of return to use?â–¾
The S&P 500 has historically returned approximately 10% annually before inflation, or about 7% after inflation. For conservative projections, use 6-7%. For aggressive growth portfolios, 8-10% is reasonable. Bond-heavy portfolios typically return 3-5%. High-yield savings accounts currently offer 4-5%.
Should I account for inflation?â–¾
Yes. To see your future value in today's purchasing power, subtract the inflation rate (historically ~3%) from your expected return. So if you expect 8% returns, use 5% to get inflation-adjusted projections. This gives a more realistic picture of future buying power.
How does compound interest differ from simple interest?â–¾
Simple interest is calculated only on the original principal. If you invest $10,000 at 5% simple interest, you earn $500/year forever. With compound interest, you earn $500 in year 1, then $525 in year 2 (5% of $10,500), then $551.25 in year 3, and so on. Over long periods, the difference is enormous.
What is the Rule of 72?â–¾
The Rule of 72 is a quick mental math trick: divide 72 by your annual return rate to estimate how many years it takes to double your money. At 7% returns, your money doubles approximately every 10.3 years (72 ÷ 7 = 10.3). At 10%, it doubles every 7.2 years.
Does this calculator account for taxes?â–¾
This calculator shows pre-tax growth. In tax-advantaged accounts (401(k), IRA, Roth IRA, ISA), your investments grow tax-free or tax-deferred, so the results are accurate. In taxable brokerage accounts, you'll owe taxes on dividends and capital gains, reducing effective returns by 1-2% depending on your tax bracket.
Calclypso Editorial Team
Reviewed by certified financial professionals. Last updated: April 2026. Compound interest formula follows standard financial mathematics used by SEC and FINRA.