What is compound interest?
Last updated August 2026
Short answer
The arithmetic is taught to teenagers and consistently underestimated by adults, because people intuitively model growth as a straight line.
The mechanism
Simple interest pays on the original amount only: $1,000 at 7% pays $70 every year forever.
Compound interest pays on the accumulated total. Year two earns 7% on $1,070, year three on $1,144, and the increment grows every year.
Nothing else happens. The entire effect comes from the base expanding, which is why it is invisible early and dramatic late.
Why time beats rate
Doubling periods stack, and the final doubling is larger than every previous one combined.
Someone investing for forty years captures several more doublings than someone investing for twenty, and the extra ones are the large ones.
This is why a delayed start is expensive in a way that feels disproportionate: the years lost are the ones at the end, not the beginning.
Where investing differs from a savings account
A savings rate is stated in advance. Investment returns are an average of a path that includes losing years.
Averages also mislead after losses. A 50% fall requires a 100% gain to recover, so volatility drags on the compounded result even when the average looks fine.
Long horizons are what make the average meaningful. Over short ones the sequence dominates and compounding is not the useful mental model.
Try it in Walnut
Walnut reads your connected brokerage and can show what your actual holdings have earned, including reinvested distributions, rather than a modelled projection.
How costs compound against you
A fee removes money that would otherwise have compounded, so its cost is far larger than the annual percentage suggests.
Over thirty years, a percentage point of annual cost consumes a substantial share of the final balance, which is the whole case for low-cost index funds.
Debt runs the same machinery in reverse, and credit card balances compound faster than any portfolio reliably grows.
What to do with this
Start, at whatever amount is sustainable. A small contribution beginning now generally beats a larger one beginning in five years.
Automate it, so the decision is made once rather than monthly.
Keep costs low and let time do the work, since the two variables you genuinely control are how much you invest and what you pay for it.
A worked example
$500 a month at 7% for ten years contributes $60,000 and ends near $86,000. The extra is return on contributions and return on that return.
Run the same contribution for thirty years and the contributions total $180,000 while the balance approaches $600,000. Tripling the time did far more than tripling the money.
The difference is entirely in the later years, where the base is largest. That is the argument for starting, and it does not depend on choosing well.
Sources
The SEC publishes a compound interest calculator and general guidance for savers at investor.gov. Walnut is informational and is not an investment adviser. This guide is educational and not personalized investment advice.
FAQ
What is compound interest?
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Earning a return on your returns as well as on the original amount. $1,000 growing at 7% earns $70 in year one, then earns 7% on $1,070 in year two. The base keeps growing, so each year adds more than the last.
What is the rule of 72?
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A shortcut for how long money takes to double: divide 72 by the annual return. At 7% that is about ten years, at 9% about eight. It is an approximation and it is close enough for mental arithmetic at ordinary rates.
Does compounding work the same for investments as for savings?
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The mechanism is identical, the reliability is not. A savings account compounds a stated rate predictably. Investment returns compound too, but they arrive unevenly and include losing years, so the average hides a much bumpier path.
Why does starting early matter so much?
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Because the last doublings are the largest. Money invested at 25 has time for several doublings; the same amount at 45 has time for fewer, and the missing ones are the biggest. That is why a decade of delay costs more than it looks.
Does compounding work against me anywhere?
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Yes, on debt and on fees. Credit card balances compound in the lender's favour, and an annual fee compounds against you by removing money that would have grown. A percentage point of cost over decades is a large share of the final balance.
Do I need to reinvest dividends for it to work?
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For the dividend portion, yes. A dividend taken as cash and spent stops compounding. Reinvesting buys more shares which pay more dividends, which is the same mechanism applied to income rather than to price.
What does compounding look like in numbers?
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$500 a month at 7% contributes $60,000 over ten years and reaches roughly $86,000. Over thirty years the contributions total $180,000 and the balance approaches $600,000. Tripling the time did far more than tripling the money.
Does compounding frequency matter?
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Slightly, and less than people expect. Daily against monthly compounding at the same annual rate produces a small difference, while an extra decade of time or a percentage point of fees produces a large one. Focus on time and cost rather than the compounding schedule.