{"id":3117,"date":"2022-02-16T08:32:54","date_gmt":"2022-02-16T08:32:54","guid":{"rendered":"https:\/\/wealthface.com\/blog\/?p=3117"},"modified":"2022-07-05T12:56:01","modified_gmt":"2022-07-05T12:56:01","slug":"compound-interest","status":"publish","type":"post","link":"https:\/\/wealthface.com\/blog\/compound-interest\/","title":{"rendered":"Compound Interest: Explanation, Formula, & Calculation"},"content":{"rendered":"
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Compound interest is a simple idea, but can be a little tricky to wrap your head around. In this article, we\u2019ll take a look at the concept of compound interest, explain why it is such a powerful force for investors, and how you can use it to your advantage.<\/p>\n\n\n\n

Compound Interest Explanation<\/strong><\/h2>\n\n\n\n

Let\u2019s start with the basics. When you put money into an investment<\/a>, you will generally receive extra money each year as a return on your investment<\/a>. This return is normally expressed as a percentage of the amount of money you invested in the first place \u2013 called the \u201cprincipal\u201d. <\/p>\n\n\n\n

Let\u2019s say you invested $1,000, and the return you receive is 10% \u2013 this means that at the end of the first year, you will have your original $1,000, plus an extra 10%. That\u2019s $1,100.<\/p>\n\n\n\n

Next year, your money will be reinvested, but now there is more in the account. A higher principal, in other words. If your returns stay the same at 10%, the next year you will receive 10% on the new amount.<\/p>\n\n\n\n

10% of $1,100, which is $110 \u2013 $10 more than the year before. This means that at the end of the second year, you\u2019ll have $1,210. <\/p>\n\n\n\n

This process will continue each year (or however often your investment is \u201ccompounded\u201d). By the end of the 10th year, you’ll have $2,594, more than double your initial savings (without adding any more of your own money after your initial investment). You can thank compound interest for that.<\/p>\n\n\n\n

Your investment would grow like this:<\/strong><\/p>\n\n\n\n

Year<\/strong><\/td>Investment<\/strong><\/td><\/tr><\/thead>
0<\/td>$1,000.00<\/td><\/tr>
1<\/td>$1,100.00<\/td><\/tr>
2<\/td>$1,210.00<\/td><\/tr>
3<\/td>$1,331.00<\/td><\/tr>
4<\/td>$1,464.10<\/td><\/tr>
5<\/td>$1,610.51<\/td><\/tr>
6<\/td>$1,771.56<\/td><\/tr>
7<\/td>$1,948.72<\/td><\/tr>
8<\/td>$2,143.59<\/td><\/tr>
9<\/td>$2,357.95<\/td><\/tr>
10<\/td>$2,593.74<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

At a basic level, you can think of compound interest as \u201cinterest on interest\u201d. As you receive returns on your investments, your principal will continue to grow, and you will receive higher returns every year, even if you don\u2019t invest any more money.<\/p>\n\n\n\n

Compound Interest Formula<\/strong><\/h2>\n\n\n\n

There are a number of ways of working out the returns you can realize from compound interest. The simple way is the one we\u2019ve presented above \u2013 for each year, you can complete the same basic sum, and repeat this to work out how much money you will have in ten years, twenty years, or when you retire<\/a>.<\/p>\n\n\n\n

There are easier ways to get to the same number, though. The standard compound interest formula is:<\/p>\n\n\n\n

A = P(1+r\/n)nt<\/sup><\/strong><\/p>\n\n\n\n