Albert Einstein is believed to have said that compound interest is one of the most powerful forces on earth, and we think he's right.
Compound interest allows your money to continue growing faster and faster and faster the longer you have it invested because the interest you earn is rolled back into your principal so it can start earning interest as well.
To understand why compound interest is so great, you have to see it side by side with simple interest. We could sit here and try to explain the concept with words, but the numbers really do all of the talking.
In this example, we are using a starting principal balance of $10,000 and a 10 percent interest rate. With simple interest, the principal balance remains the same throughout, but with compound interest, the interest payment is rolled into the principal each year.
Simple Interest
Compound Interest
Principal
Interest $
Total Interest
Principal
Interest $
Total Interest
$10,000
$1,000
$1,000
$10,000
$1,000
$1,000
$10,000
$1,000
$2,000
$11,000
$1,100
$2,100
$10,000
$1,000
$3,000
$12,100
$1,210
$3,310
$10,000
$1,000
$4,000
$13,310
$1,331
$4,641
$10,000
$1,000
$5,000
$14,641
$1,464
$6,105
$10,000
$1,000
$6,000
$16,105
$1,611
$7,716
$10,000
$1,000
$7,000
$17,715
$1,772
$9,488
$10,000
$1,000
$8,000
$19,487
$1,949
$11,437
$10,000
$1,000
$9,000
$21,436
$2,144
$13,581
$10,000
$1,000
$10,000
$23,579
$2,358
$15,939
As you can see, at the end of 10 years, you receive more than 50 percent more money in interest payments with compound interest ($15,939) than you do with simple interest ($10,000).
Video: Compound Interest
Now that you've got the basics of compound interest, check out the video below and see what else you can learn about compound interest at the whiteboard.
Taking Your Next Step
Once you're comfortable with compound interest, it's time to move on and learn about the Time Value of Money.
