How Compound Interest Works
Compound interest is interest earned on interest. When you invest, you earn returns on your original money — and then you earn returns on those returns. Over time, this creates a snowball effect that grows your money faster than simple interest ever could.
The formula for compound interest is:
A = P(1 + r/n)^(nt) + PMT × [((1 + r/n)^(nt) - 1) / (r/n)]
Where:
- A = Future value of the investment
- P = Initial principal (your starting amount)
- r = Annual interest rate (as a decimal)
- n = Number of times interest compounds per year
- t = Number of years
- PMT = Regular contribution per period
Why Start Early
The most powerful factor in compound interest is time. Invest $10,000 at age 25 with $500 monthly contributions at 8% returns, and you'll have over $1.4 million by age 60. Start at 35 with the same numbers, and you'll have about $600,000. That 10-year difference costs you roughly $800,000.