Imagine you plant one magic bean. It grows into a plant that makes 2 more beans. Then those beans each grow into plants that make 2 more beans. Your beans keep making more beans! That’s compound interest.
Compound interest means you earn interest on your interest. It’s what makes your money grow faster and faster over time, like a snowball rolling downhill.
Simple Interest vs. Compound Interest
Simple interest is like getting paid once for doing a chore. If you have $100 earning 10% simple interest, you get $10 every year. After 3 years, you have $130.
Compound interest is like getting paid for the chore AND for all the previous payments. With $100 earning 10% compound interest:
- Year 1: $100 + $10 = $110
- Year 2: $110 + $11 = $121
- Year 3: $121 + $12.10 = $133.10
See how you earned $3.10 more? That difference gets much bigger over decades.
Why It Matters
Albert Einstein supposedly called compound interest “the eighth wonder of the world.” Whether he actually said that or not, the math is powerful:
- $1,000 invested at 7% for 10 years = $1,967
- $1,000 invested at 7% for 30 years = $7,612
- $1,000 invested at 7% for 40 years = $14,974
The money didn’t just grow — it exploded in the later years. That’s the magic of compound interest.
The Flip Side
Compound interest works against you with debt. Credit card interest compounds too, which is why a small balance can grow into a huge one if you only make minimum payments.
The Bottom Line
Compound interest is your money making money on its money. Start early, be patient, and let time do the heavy lifting.