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How does compound interest work?

Compound interest is when you earn interest on the money you’ve saved and on the interest you earn along the way.

Here’s an example to help explain compound interest.

Data for your calculations Explanations

Amount you start with

$1,000

Also called your principal

How much you earn

5 percent

Also called your interest rate, or rate of return

How often you calculate interest

Once a year

Also called your compounding frequency

Amount after the first year

$1,050

Amount you started the year with, plus 5 percent
0.05 x $1,000 = $50
$1,000 + $50 = $1,050

Amount after the second year

$1,102.50

Amount you started the year with, plus 5 percent
0.05 x $1,050 = $52.50
$1,050 + $52.50 = $1,102.50

Increasing the compounding frequency, finding a higher interest rate, and adding to your principal amount are ways to help your savings grow even faster.

You can also crunch numbers using different interest rates, periods of time, and compounding frequencies at the Securities and Exchange Commission’s website Investor.gov .