📖 How Compound Interest Works
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. It's often called "interest on interest" and is the reason your money can grow exponentially over time.
- Initial investment: Start with a lump sum
- Interest rate: The annual return you expect (7% is a common stock market average)
- Regular contributions: Add money monthly to accelerate growth
- Time: The longer you invest, the more powerful compound interest becomes
📐 The Formula
Where: A = Future value, P = Principal, r = Annual rate, n = Compounds per year, t = Years
The Rule of 72
Quick estimate: Divide 72 by your interest rate to find how many years it takes to double your money.
- At 6%: 72 ÷ 6 = 12 years to double
- At 8%: 72 ÷ 8 = 9 years to double
- At 10%: 72 ÷ 10 = 7.2 years to double
❓ Frequently Asked Questions
Historical stock market returns average 7-10% annually (adjusted for inflation: 5-7%). Savings accounts offer 0.5-5%. Bonds typically 3-5%. Use conservative estimates for planning.
More frequent compounding = slightly more growth. But the difference is small. Monthly vs annual compounding on $10,000 at 7% for 20 years differs by only ~$500.
Time is your biggest asset. $10,000 invested at 7% for 40 years = $150,000. For 20 years = $39,000. Starting 20 years earlier nearly quadruples your money!
No. Investment gains may be taxed. Use tax-advantaged accounts (401k, IRA, Roth) when possible. Actual returns depend on your tax situation.