What is compound interest?

Compound interest refers to the method of calculating interest in which interest is added to the principal so that, from that moment on, the interest that has been added also earns interest. This means that over time, the investment grows at an accelerating rate because you earn interest not only on your original principal but also on the interest that has been previously accumulated. This concept is fundamental in finance and investing, as it illustrates the power of reinvesting returns.

The accumulation effect of compound interest can lead to significant growth of an investment over time, particularly when the investment period is long and the interest rate is reasonably high. This is in contrast to simple interest, which only applies to the initial principal without considering any accumulated interest. In this way, the correct understanding of compound interest highlights its role in wealth accumulation and long-term financial planning.