Compound Interest
Interest earned on both the original principal and previously accumulated interest. The mathematical engine behind long-term wealth and unmanageable debt.
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Unlike simple interest (which only ever applies to the original amount), compound interest causes balances to grow exponentially over time.
The formula is A = P(1 + r)ⁿ, where A is the final amount, P is the principal, r is the interest rate per period, and n is the number of periods. Small differences in rate or time produce large differences in outcome over decades.
A useful approximation is the Rule of 72: divide 72 by the annual interest rate to estimate how many years it takes for an investment to double. For example, money earning 7% per year doubles roughly every 10 years. Compound interest works dramatically in favour of long-term investors and dramatically against people carrying high-interest debt.