What is compound interest?

Compound interest refers to the process where interest is calculated not only on the initial principal but also on the accumulated interest from previous periods. This means that each time interest is added to the principal, the new total (which includes both the principal and the previously accumulated interest) serves as the basis for calculating future interest. This compounding effect leads to exponential growth of the investment or loan over time, making it a powerful financial tool.

Understanding the concept of compound interest is crucial for long-term financial planning, as it can significantly enhance the value of savings or investments compared to simple interest, which only considers the original principal amount. This principal distinction allows individuals to better forecast their financial growth over time and make more informed investment choices.