Compound Interest (Savings)
Definition
Interest calculated on both the initial principal and previously accumulated interest, causing savings to grow exponentially rather than linearly over time.
Compound interest is interest earned on interest. If you deposit $10,000 in a savings account earning 5% APY, you earn $500 in year one (total: $10,500). In year two, you earn 5% on $10,500 = $525 (total: $11,025). Each year, the interest amount grows because the base amount is larger.
The compounding frequency matters. Daily compounding (standard for savings accounts) produces slightly more than monthly or annual compounding. A $10,000 deposit at 5% yields $10,512.67 with daily compounding vs $10,500 with annual compounding — a small difference that grows more significant over longer periods and larger balances.
The Rule of 72 provides a quick estimate of how long it takes to double your money: divide 72 by the interest rate. At 6%, your money doubles in approximately 12 years. At 10%, about 7.2 years. This simple rule illustrates why starting early is so powerful — each doubling period multiplies all previous growth.
Compound interest works against you on debt. Credit card balances at 20% APR compound monthly, meaning interest charges generate their own interest charges. A $5,000 balance paying only minimum payments can take 15+ years to pay off, with total interest exceeding the original balance.
Einstein allegedly called compound interest the eighth wonder of the world. Whether or not he actually said it, the principle holds: time is the most powerful variable in the compounding equation. Starting 10 years earlier with less money often beats starting later with more money, because those extra years of compounding create exponential growth.
Where this appears in Clarity
Clarity automatically tracks and calculates these concepts across your connected accounts.
Related Terms
Frequently Asked Questions
How often does compound interest compound?
Most savings accounts compound daily. CDs typically compound daily or monthly. Credit cards compound daily on outstanding balances. The more frequent the compounding, the faster the growth (for savings) or the faster debt accumulates (for loans). APY already accounts for compounding frequency.
Is compound interest the same as APY?
APY (Annual Percentage Yield) reflects the total return including compounding. A 5% APR compounded daily produces a 5.13% APY. When comparing savings accounts, always use APY since it accounts for compounding differences. APR is the simple rate before compounding.