Compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. It is different from simple interest, which is only calculated on the original principal amount.
With compound interest, the interest earned in each period is added to the principal, and interest is then calculated on the new, higher balance. This means that the interest earned in one period earns interest in the next. The more frequently the interest is compounded, the more quickly the interest will accumulate.
For example, if you deposit $1000 in a bank account that pays 5% annual interest compounded annually, you will earn $50 in interest in the first year. In the second year, you will earn 5% on the new balance of $1050, which is $52.50.
Compound interest can be a powerful tool for saving and investing, as it allows your money to grow at an increasingly faster rate over time. It is also used in loans, where it can significantly increase the total cost of borrowing over time.
It’s important to understand the compound interest when you’re comparing investment options or taking out a loan so that you can make informed decisions.