How does compound interest work?
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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 |
Amount after the second year |
$1,102.50 |
Amount you started the year with, plus 5 percent |
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 .