Compound interest is the interest that is calculated on both the initial principal and the accumulated interest of a deposit or loan. It means that your money grows faster over time because you earn interest on your interest. For example, if you invest $1000 at 10% annual interest rate compounded annually, after one year you will have $1100 ($1000 + $100), after two years you will have $1210 ($1100 + $110), after three years you will have $1331 ($1210 + $121), and so on.
The formula for compound interest is:
A is the future value,
P is the initial principal,
r is the annual interest rate,
n is the number of times the interest is compounded per year, and
t is the number of years.
Compound interest is important because it can help you grow your wealth over time. It can also help you save for your future goals such as retirement, education, or buying a house. The more time you have to invest, the more compound interest can work in your favor. For example, if you invest $1000 at 10% annual interest rate compounded annually for 20 years, you will have $6727.50 at the end. But if you invest for 30 years instead, you will have $17449.40 at the end. That’s a huge difference!
Compound interest can also work against you if you borrow money at a high-interest rate and don’t pay it back quickly. For example, if you borrow $1000 at 20% annual interest rate compounded monthly for one year, you will owe $1268.24 at the end. That’s more than a quarter of what you borrowed!