Compound interest is the process of earning interest on your interest. Unlike simple interest, which only calculates returns on your original principal, compound interest adds each period's earnings back to the base, creating exponential growth over time.
Here is a concrete example: if you invest $10,000 at a 7% annual return, after one year you have $10,700. In year two, you earn 7% on $10,700 (not just $10,000), giving you $11,449. By year 30, your $10,000 grows to over $76,000 — without adding a single extra dollar.
The Rule of 72
The Rule of 72 is a quick mental shortcut to estimate how long it takes for an investment to double. Simply divide 72 by your annual interest rate. At 7% returns, your money doubles roughly every 10.3 years. At 10%, it doubles every 7.2 years.
This rule highlights why starting early matters so much. A 25-year-old who invests $5,000 per year at 7% will have roughly $1.07 million by age 65. A 35-year-old doing the same ends up with about $505,000 — roughly half — despite only missing 10 years of contributions. Those early dollars had more time to compound.
Compounding Frequency Matters
How often interest compounds affects your total returns. The more frequently interest is calculated and added to your balance, the faster your money grows:
- Annual compounding: Interest calculated once per year. $10,000 at 5% = $10,500 after one year.
- Monthly compounding: Interest calculated 12 times per year. $10,000 at 5% = $10,511.62 after one year.
- Daily compounding: Interest calculated 365 times per year. $10,000 at 5% = $10,512.67 after one year.
Where to Earn Compound Interest in 2026
In 2026, several accessible options let you harness compound interest:
- High-yield savings accounts (HYSAs): Currently offering 4.0–4.5% APY with FDIC insurance. Your interest compounds daily or monthly.
- Certificates of deposit (CDs): Lock your money for a fixed term (3 months to 5 years) at rates around 4.0–4.75% APY.
- Index funds and ETFs: Historically returning 7–10% annually over long periods. Reinvesting dividends compounds your returns.
- Treasury I Bonds: Government-backed bonds with rates that adjust for inflation. Currently offering competitive real returns.
- 401(k) and IRA accounts: Tax-advantaged retirement accounts where your investments compound without annual tax drag.
The Dark Side: Compound Interest on Debt
Compound interest works both ways. When you carry a credit card balance at 20%+ APR, that interest compounds against you. A $5,000 credit card balance at 22% APR making only minimum payments takes over 20 years to pay off and costs more than $8,000 in interest — more than the original balance.
This is why paying off high-interest debt is one of the best financial moves you can make. Eliminating a 22% APR balance is equivalent to earning a guaranteed 22% return on your money.
Try the Compound Interest Calculator
Put this knowledge into action with our free calculator. Get instant, personalized results.
Frequently Asked Questions
What is the difference between simple and compound interest?
Simple interest calculates returns only on the original principal. Compound interest calculates returns on the principal plus all accumulated interest. Over time, compound interest produces significantly higher returns because you earn interest on your interest.
How often should interest compound for the best returns?
More frequent compounding produces slightly higher returns. Daily compounding is better than monthly, which is better than quarterly or annual. However, the difference between daily and monthly compounding is relatively small. The interest rate and time horizon matter far more than compounding frequency.
How much do I need to invest to become a millionaire?
At a 7% average annual return, investing $500 per month starting at age 25 would grow to approximately $1.2 million by age 65. Starting at age 35, you would need roughly $1,000 per month to reach the same goal. The key takeaway: the earlier you start, the less you need to invest each month.
Does compound interest work on debt too?
Yes, and this is why high-interest debt is so damaging. Credit cards, payday loans, and other high-APR debts compound interest against you. A $5,000 credit card balance at 22% APR compounding monthly grows by over $1,100 per year in interest alone if unpaid. Paying off high-interest debt is effectively earning a guaranteed return equal to that interest rate.