What is compound interest?

How compounding works

Suppose $1,000 earns 5% once per year. After year one, the balance is $1,050. In year two, 5% applies to $1,050 rather than only the original $1,000, so the balance becomes $1,102.50. The second year adds $52.50: $50 on the starting principal and $2.50 on the first year's interest.

This reproduces the example published by the Consumer Financial Protection Bureau.

Simple interest versus compound interest

Simple interest uses the original principal as its base each period. At 5%, $1,000 earns $50 each year, so two years would produce $1,100. Compound interest adds earned interest to the base. Under annual compounding, the same inputs produce $1,102.50 after two years.

The difference begins small and grows with more time, a higher rate, or more frequent compounding. Regular deposits add another source of growth because each deposit can earn interest after it enters the balance.

The inputs that change the result

• Starting amount: the balance available before the first period.
• Annual rate: the fixed nominal rate assumed by the projection.
• Time: the number of years growth and deposits continue.
• Contributions: new money added on a regular schedule.
• Compounding frequency: how often interest is added to the balance.
• Contribution timing: whether each deposit arrives before or after that period's growth.

Explore these inputs with the compound interest calculator, or see the exact formula on the methodology page.

What compound interest does not guarantee

A fixed-rate calculation is a scenario, not a forecast. Bank products may use specific daily-balance and crediting rules. Investment returns can change and can be negative. Taxes, fees, inflation, withdrawals, and missed deposits can also change the outcome.

For another independent implementation, compare the same inputs with the Investor.gov compound interest calculator.