What Is Compound Interest?
Albert Einstein allegedly called compound interest "the eighth wonder of the world." It's the process where the interest your money earns begins earning its own interest — creating exponential growth over time.
The Compound Interest Formula
A = P(1 + r/n)^(nt)
- A = Final amount
- P = Principal (initial investment)
- r = Annual interest rate (decimal)
- n = Compounding frequency per year
- t = Time in years
The Power of Starting Early
Time is the most powerful factor in compound interest. Consider two investors:
- Investor A invests $5,000/year from age 25-35 ($50,000 total), then stops. By age 65 at 7% return: ~$602,000
- Investor B invests $5,000/year from age 35-65 ($150,000 total). By age 65 at 7% return: ~$540,000
Investor A ends up with more money despite contributing one-third as much — all because of starting 10 years earlier.