What is compound interest?
Compound interest is interest earned on interest. Unlike simple interest, which only pays on the original principal, compound interest pays on both the principal and any accumulated interest. Over time, this creates an accelerating effect — your money grows faster the longer it compounds.
The Rule of 72: a mental shortcut
The Rule of 72 is a quick way to estimate how long it takes for an investment to double. Divide 72 by your expected annual return. At 7%, money doubles in roughly 10.3 years (72 ÷ 7). At 10%, it doubles in 7.2 years. This rule works for any growth rate — it also tells you how fast inflation cuts your purchasing power in half.
Starting early vs starting big
Two investors both earn a 7% return. Chloe starts at 25 and invests $5,000 per year for 10 years, then stops. Ryan starts at 35 and invests $5,000 per year for 30 years. At 65, Chloe has about $602,000 despite investing only $50,000 total. Ryan has about $472,000 despite investing $150,000. Time beats total contributions.
Compounding frequency matters — but not that much
Daily compounding produces slightly more growth than monthly, which beats annual. On a $10,000 balance at 6% over 20 years, annual compounding yields $32,071, monthly yields $33,102, and daily yields $33,197. The difference is real, but what matters much more is the rate of return and how long you stay invested.
The dark side: compound interest on debt
Compound interest works against you when you carry debt. A $5,000 credit card balance at 22% APR, if you make only minimum payments, can take over 20 years to pay off and cost thousands in interest. The same mathematical force that builds wealth also destroys it — depending on which side of the equation you're on.
How to put compound interest to work for you
- Start investing as early as possible, even with small amounts.
- Reinvest dividends and capital gains rather than cashing them out.
- Choose low-cost index funds and ETFs to minimize the fees that eat into compounding.
- Automate your investments so you never miss a contribution.
// Glossary Highlights
- Compound growth — growth that builds on itself, where returns generate their own returns.
- Interest rate — the percentage at which money grows or the cost of borrowing.
- Index fund — a mutual fund that tracks a market index, offering broad diversification at low cost.
- ETF — an exchange-traded fund, similar to an index fund but traded like a stock.
- Savings rate — the percentage of your income you save and invest.
// FAQ
Q: What is the Rule of 72?
A: Divide 72 by your annual return rate to estimate how long it takes for an investment to double. At 7%, money doubles in about 10.3 years.
Q: Why does starting early matter so much?
A: Time is the most powerful multiplier. Starting at 25 instead of 35 can more than double your final portfolio, even if you invest the same total amount.
Q: Does compounding frequency make a big difference?
A: Daily, monthly, or annual compounding produces modest differences. The rate of return and the time invested matter far more than the compounding frequency.
// Key Takeaways
- Compound interest accelerates wealth-building by earning returns on past returns.
- The Rule of 72 gives you a quick estimate of how fast your money doubles.
- Starting early beats starting big — time is the most powerful variable in the equation.
- Compound interest works against you with debt, so pay off high-interest balances aggressively.
// Next Steps
See what your money can become with the Investment Growth Calculator. Then check your current pace with the Savings Rate Calculator.
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