Simple Interest vs Compound Interest
The key difference is that simple interest is calculated only on the original principal, while compound interest is calculated on the principal plus all previously earned interest — meaning your interest earns interest.
Simple Interest Formula
A = P × (1 + r × t) — where P = principal, r = annual rate, t = time in years.
Example: 0,000 at 5% for 5 years = 0,000 × (1 + 0.05 × 5) = 2,500
Compound Interest Formula
A = P × (1 + r/n)^(n×t) — where n = compounding frequency per year.
Example: 0,000 at 7% compounded monthly for 10 years = 0,097 — more than doubling the investment!
The Power of Compounding
Albert Einstein reportedly called compound interest the "eighth wonder of the world." The reason is dramatic long-term growth. 0,000 invested at 7% for 30 years grows to over 6,000 with compound interest versus just 1,000 with simple interest. Starting early makes an enormous difference.
Frequently Asked Questions
Which is better — simple or compound interest? +
For investing, compound interest is always better — your returns grow exponentially over time. For borrowing, simple interest is better as a borrower since you pay less overall. Most savings accounts, investments and mortgages use compound interest. Most short-term loans and bonds use simple interest.
How often should interest compound? +
More frequent compounding means more growth. Daily compounding produces slightly more than monthly, which produces more than annually. However, the difference between daily and monthly compounding is very small. The interest rate and time period have far more impact than compounding frequency.
What is the Rule of 72? +
The Rule of 72 is a quick mental shortcut to estimate how long it takes for an investment to double. Divide 72 by the annual interest rate. For example: at 6% interest, 72 ÷ 6 = 12 years to double. At 9%, it takes 72 ÷ 9 = 8 years to double.
Does inflation affect compound interest? +
Yes — to find your real return, subtract the inflation rate from your interest rate. If you earn 7% but inflation is 3%, your real return is about 4%. This is why financial advisors recommend investments that beat inflation, not just match it.
