Compound interest

Compound interest

Interest paid on previously earned interest as well as on the principal.

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compound interest

Interest paid both on principal and on interest earned during previous compounding periods. Essentially, compounding involves adding interest to the sum of principal and any previous interest in order to calculate interest in the next period. Compare simple interest. See also frequency of compounding.

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Compound interest. When the interest you earn on an investment is added to form the new base on which future interest accumulates, it is compound interest.

For example, say you earn 5% compound interest on $100 every year for five years. You'll have $105 after one year, $110.25 after two years, $115.76 after three years, and $127.63 after five years.

Without compounding, you earn simple interest, and your investment doesn't grow as quickly. For example, if you earned 5% simple interest on $100 for five years, you would have $125. A larger base or a higher rate provide even more pronounced differences.

Compound interest earnings are reported as annual percentage yield (APY), though the compounding can occur annually, monthly, or daily.