COMPOUNDED INTEREST
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Interest calculated on the initial principle which also includes all accumulated interest from previous periods on a deposit or loan.
Summary
Compound interest is the interest earned on both the original principal amount and the accumulated interest from previous periods. Unlike simple interest which only calculates interest on the principal, compound interest creates a 'snowball effect' where your money grows exponentially over time. The key concept is that interest earns interest, making it one of the most powerful tools for building wealth when saving and investing, but also a costly burden when borrowing.
Usage Context
Essential for understanding investment growth, loan calculations, retirement planning, comparing financial products, and making informed decisions about saving versus spending. Critical foundation for topics like present value, future value, and annuities.
Common Confusions
- Thinking compound interest only applies to savings accounts
- Not understanding how compounding frequency affects growth
- Confusing compound interest with simple interest calculations
- Underestimating the impact of time on compound growth
- Not realizing compound interest works both for and against you depending on whether you're lending or borrowing
