Compound Interest Explained
Albert Einstein allegedly called it the eighth wonder of the world. Whether or not he actually said that, compound interest is the single most powerful force in building long-term wealth — and the most destructive force when it works against you.
The Core Concept: Interest Earning Interest
Simple interest is straightforward: you earn interest only on your original investment. Deposit $1,000 at 7% simple interest and you earn $70 every year, forever. After 10 years: $1,700.
Compound interest is different: you earn interest on your original investment plus all the interest you've already earned. That $1,000 at 7% compound interest earns $70 the first year, but $74.90 the second year (7% of $1,070), then $80.14 the third year, and so on. After 10 years: $1,967.
The difference seems small at first. But this is the snowball effect — each year, your base grows larger, which means the next year's interest is larger, which means the base grows even faster. Over decades, the gap between simple and compound interest becomes enormous. That same $1,000 at 7% after 40 years? Simple interest gives you $3,800. Compound interest gives you $14,974.
The Math Made Simple
Watch how $10,000 grows at 7% annual return with no additional contributions. Notice how later decades contribute dramatically more growth than earlier ones:
10 Years
$19,672
$9,672 in growth
20 Years
$38,697
$28,697 in growth
30 Years
$76,123
$66,123 in growth
40 Years
$149,745
$139,745 in growth
Key insight: In the first decade, your money grew by ~$9,700. In the fourth decade alone, it grew by ~$73,600 — nearly 8x more growth from the same investment, just with more time.
The Rule of 72
Want a quick way to estimate how long it takes to double your money? Divide 72 by your annual interest rate. The result is the approximate number of years to double.
3%
24 years
Savings account
5%
14.4 years
Bonds / conservative portfolio
7%
10.3 years
Stock market (historical avg)
10%
7.2 years
Aggressive growth portfolio
12%
6 years
High-growth / venture returns
20%
3.6 years
Credit card debt (working against you)
Notice that last row: credit card debt at 20% doubles what you owe in under 4 years. The same math that builds wealth can destroy it.
Why Starting Early Dominates
This is the most counterintuitive lesson in personal finance. Time matters more than the amount you invest. Here's a side-by-side comparison that proves it:
Person A (Early Start)
Invests $200/month from age 25 to 35, then stops completely. Never invests another dollar. Assumes 8% annual return.
Person B (Late Start)
Invests $200/month from age 35 to 65 — three times as long, three times as much money invested. Assumes 8% annual return.
Person A invested 3x less money but ended up with ~75% more. Those early dollars had 30 extra years to compound. Each doubling period multiplied not just the contributions, but all the accumulated growth from prior decades. This is why the best time to start investing is always now.
Compound Interest Working Against You
The same exponential force that builds wealth in your investment accounts destroys it in your debt accounts. High-interest debt compounds against you faster than most investments compound for you.
Credit Card
A $5,000 balance at 22% APR making minimum payments takes 20+ years to pay off and costs over $12,000 in interest alone — more than double the original debt.
Personal Loan
More manageable, but still compounds against you. A $10,000 loan at 12% costs $3,346 in interest over 5 years. Pay these off before investing beyond employer match.
Student Loans
Lower rates mean you might invest simultaneously. If your investment returns exceed the loan rate, mathematically you come out ahead — but being debt-free has psychological value too.
Practical Takeaways
Start now with whatever you have
$50/month starting today beats $500/month starting in 10 years. The biggest advantage you have is time, and every day you wait costs you.
Prioritize killing high-interest debt
Compound interest works both ways. Paying off a 22% credit card is the equivalent of earning a guaranteed 22% return — no investment can match that.
Don't withdraw early
Every dollar you withdraw loses decades of future compounding. A $1,000 withdrawal at age 30 isn't $1,000 — it's $10,000+ you'll never have at retirement.
Increase contributions over time
Every raise is an opportunity. If you get a 5% raise, invest half of it. You'll barely notice the difference in lifestyle, but compounding will amplify those extra dollars enormously.
Reinvest dividends
Dividend reinvestment is compound interest in action. Historically, reinvested dividends account for roughly 40% of total stock market returns over long periods.
Think in decades, not years
Compounding is boring for years, then suddenly explosive. A 7% return doubles your money every 10 years. In 40 years, that's 4 doublings: $10K becomes $160K without adding a cent.
Just Starting Out
Open an investment account and start with any amount — even $25/month. Automate it so you never have to think about it. Your biggest asset right now is time, and every month you delay costs more than you think. Perfection is the enemy of starting.
Already Investing
Stay the course. Resist the urge to withdraw during downturns — that's when you're buying at a discount. Increase contributions with every raise. Reinvest all dividends. The boring middle years are where compounding does its heaviest lifting.
Carrying Debt
Compound interest is working against you right now. Attack high-interest debt aggressively — especially credit cards. Every dollar of credit card debt you eliminate is a guaranteed 20%+ return. Once it's gone, redirect those payments into investments.