Compound Interest Explained (With Simple Examples)
🇩🇪 Diesen Artikel auf Deutsch lesenCompound interest means you earn interest on your past interest. $300 a month at a 6% annual return grows to about $139,000 after 20 years, even though you only contributed $72,000. Starting ten years earlier roughly doubles the result again.
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Albert Einstein probably never called compound interest the eighth wonder of the world, but the idea behind the quote is right: given enough time, growth on growth becomes the biggest part of your savings.
Simple vs. compound interest
With simple interest, you earn interest only on your original deposit. $10,000 at 5% earns $500 every year — $5,000 after ten years.
With compound interest, each year’s interest is added to the balance and earns interest itself. The same $10,000 at 5% grows to about $16,289 after ten years, $26,533 after twenty and $43,219 after thirty.
Why time matters more than amount
| Saver | Monthly | Years saving | Total contributed | Balance at 65 (6%) |
|---|---|---|---|---|
| Starts at 25 | $200 | 40 | $96,000 | about $398,000 |
| Starts at 35 | $200 | 30 | $72,000 | about $201,000 |
| Starts at 45 | $400 | 20 | $96,000 | about $185,000 |
The 25-year-old and the 45-year-old contribute the same total, but the early starter ends up with more than twice as much.
Compound Interest CalculatorSee how your savings grow over timeTry the calculator →The rule of 72
Divide 72 by your annual return to estimate how many years your money needs to double. At 6%, about 12 years; at 9%, about 8; at 3%, about 24. It is a handy way to compare options in your head.
What reduces compounding
- Fees: a 1% annual fund fee can reduce your ending balance by around 20% over 30 years. Low-cost index funds keep more working for you.
- Taxes: tax-advantaged accounts such as a 401(k) or IRA let your money compound without yearly tax drag.
- Inflation: a 6% nominal return with 3% inflation is a 3% real return. Think in today’s dollars for long-term planning.
- Withdrawals: taking money out early breaks the chain of growth.
Compound interest works against you, too
Credit card debt compounds the same way, usually at 20% or more. That is why paying off high-interest debt is one of the best “investments” available.
Frequently asked questions
How often is interest compounded?
Savings accounts usually compound daily or monthly. For long-term planning, the difference between monthly and yearly compounding is small compared with the effect of rate and time.
What return should I assume for stocks?
Broad US stock market returns have historically averaged around 10% per year before inflation, with large swings. Many planners use 5–7% for a cautious long-term estimate.