How Compound Interest Works
A step-by-step visual guide to understanding the most powerful force in finance
Start with your principal
Your principal is the initial amount you invest or deposit. This is the foundation your compound interest builds upon. Even a small starting amount can grow significantly over time.
Interest is calculated on your full balance
At each compounding interval — daily, monthly, quarterly, or yearly — interest is calculated as a percentage of your current balance, not just your original principal. This is the key difference from simple interest.
Interest earns interest
The calculated interest is added to your balance. In the next period, interest is calculated on this new, larger amount. This is the 'compounding' effect — your interest earns its own interest.
Growth accelerates over time
Over time, the interest-on-interest effect accelerates dramatically. The longer you leave your money invested, the steeper the growth curve becomes. This is why starting early — even with small amounts — is so powerful.
Regular contributions amplify the effect
Making regular monthly contributions dramatically amplifies the compound effect. Each contribution begins earning compound interest from the moment it's added, creating multiple parallel growth curves that compound together.