Compound Interest Explained with a Simple Example
Learn the difference between simple and compound interest, how time affects growth and what assumptions a calculator uses.
Compound interest is interest earned on both the original amount and the interest accumulated earlier. It can help savings grow over time when interest remains invested, but the result depends on the rate, compounding frequency, time period, taxes, fees and whether the rate is guaranteed.
Simple interest vs compound interest
With simple interest, interest is calculated only on the original principal. With compound interest, previously earned interest is added to the balance and can earn interest in later periods. This difference becomes more visible over longer periods, especially when the return is positive and earnings stay invested.
Compound interest formula
For a fixed annual rate compounded a set number of times each year, the future value can be estimated as:
P = starting principal; r = annual rate as a decimal; n = compounding periods per year; t = number of years.
This formula assumes a constant rate and no extra deposits or withdrawals. For recurring deposits or regular investments, a different calculation is needed.
How to use the calculator
- Enter the starting principal.
- Enter an annual rate to test a scenario.
- Choose the number of years.
- Compare the projected value with the original amount.
- Repeat at lower rates and after accounting for fees or taxes where relevant.
Common mistakes
- Assuming a projected rate is guaranteed.
- Ignoring inflation, which reduces future purchasing power.
- Comparing products without checking whether rates are before or after tax.
- Assuming the calculator includes additional deposits when it does not.
Frequently asked questions
Does compounding always make money grow?
No. The result depends on the underlying product and rate. Investment values can fall, and some products may have fees or penalties.
Is monthly compounding always better?
For the same nominal rate and otherwise identical assumptions, more frequent compounding can produce a slightly higher mathematical result. Real product terms may differ, so compare the effective rate and conditions.
Does this include tax?
No tax treatment is included in the basic estimate. Tax depends on the product and the applicable rules.
Use the compound interest calculator to test assumptions rather than treating a single output as a prediction.
Editorial note: This article is for general educational purposes. It is not financial, investment, legal or tax advice. Rates, regulations and product terms can change. Verify details with the relevant official source or institution before acting.