Compound Interest Explained: How Your Money Grows Over Time
What Is Compound Interest?
Simple interest earns returns only on your original principal. Compound interest earns returns on both your principal and your accumulated interest. Over time, this creates exponential growth rather than linear growth.
Think of it like a snowball rolling downhill. With simple interest, you add a fixed amount of snow each rotation. With compound interest, the snowball picks up more snow with each rotation because it is getting bigger — and the bigger it gets, the faster it grows.
The Rule of 72
The Rule of 72 is a quick mental shortcut for estimating how long it takes to double your money. Simply divide 72 by your annual return rate:
At a 10% annual return (the historical average for the S&P 500), $10,000 becomes $20,000 in about 7 years, $40,000 in 14 years, and $80,000 in 21 years — all without adding any new money. Each doubling happens on an increasingly larger base.
A Real-World Growth Example
Invest $10,000 at a 7% annual return with no additional contributions:
Notice how the growth accelerates. The first 10 years added $9,672, but years 30 to 40 added $73,622 — over seven times more growth in the same time period. This is the essence of compounding: the gains themselves generate gains.
How Compounding Frequency Matters
Interest can compound at different frequencies — annually, quarterly, monthly, or even daily. More frequent compounding produces slightly higher returns because interest begins earning interest sooner.
For $10,000 invested at 7% for 30 years:
The difference between annual and daily compounding is about $2,891 over 30 years — meaningful but not dramatic. In practice, most investment accounts use daily compounding, while savings accounts may compound daily or monthly. The compounding frequency matters less than the interest rate itself and the length of time your money is invested.
The Impact of Regular Contributions
The real magic happens when you combine compound interest with consistent monthly contributions. Adding $500 per month to that same $10,000 investment at 7%:
The combination of a starting balance, regular contributions, and compounding creates substantial wealth over decades. The $10,000 initial investment plus $240,000 in total contributions ($500 x 480 months) turns into $1,461,637 over 40 years — meaning compound growth generated over $1.2 million.
Why Starting Early Matters More Than Saving More
Starting at age 25 instead of 35 — with $500/month at 7% — means $1,312,407 vs. $609,986 by age 65. That extra decade of compounding produces over $700,000 more, despite only $60,000 in additional contributions ($500 x 120 months).
Here is the full picture of starting at different ages with $500/month at 7%:
A 25-year-old who invests $240,000 over 40 years ends up with over 5x that amount. A 45-year-old investing $120,000 barely doubles their money. The lesson is clear: time in the market matters more than timing the market. Read more about historical market returns in our guide to S&P 500 average returns.
The Hidden Cost of Fees
Investment fees — even small ones — can dramatically erode compound growth over decades. Consider a $100,000 investment growing at 7% for 30 years:
The difference between a 0.1% and 1.0% fee is $195,124 — nearly 2x the original investment — lost entirely to fees. The SEC recommends checking the expense ratio of any fund before investing. Low-cost index funds with expense ratios under 0.1% are widely available and can save hundreds of thousands over a career of investing.
Try It Yourself
Use our Investment Calculator to model your own compound growth scenario with custom contribution amounts, rates, and time horizons. If you are planning for retirement specifically, our Retirement Savings Calculator includes projections based on compound growth principles. The key takeaway: start as early as possible, contribute consistently, keep fees low, and let compounding do the heavy lifting.