Why is compound interest better

Popular Courses. Personal Finance Banking. Simple Interest vs. Compound Interest: An Overview Interest is the cost of borrowing money, where the borrower pays a fee to the lender for the loan.

Key Takeaways Interest is the cost of borrowing money, where the borrower pays a fee to the lender for the loan. Compound interest accrues and is added to the accumulated interest of previous periods, so borrowers must pay interest on interest as well as principal. Related Articles. Interest Rates Continuous Compound Interest. Mortgage Mortgage Calculator.

Partner Links. Related Terms Learn About Simple Interest Simple interest is a quick method of calculating the interest charge on a loan. What Is Compound Interest? Compound interest is the interest on a loan or deposit that accrues on both the initial principal and the accumulated interest from previous periods. What Is Cumulative Interest? Cumulative interest is the sum of all interest payments made on a loan over a certain time period. Rule of 72 The Rule of 72 is a shortcut or rule of thumb used to estimate the number of years required to double your money at a given annual rate of return and vice versa.

Consider the following charts from NerdWallet. It assumes you start with zero dollars and also assumes various average annual investment returns. Here's another compound interest chart, which The New York Times columnist and author Ron Lieber says changed his life. It assumes an 8 percent average annual investment return. Compound interest can also work against you when it comes to loans: It means that every year or month, whatever the frequency specific to your loan, the amount you have to repay gets bigger.

The sooner you invest your money, the more you'll benefit from compound interest. So where should you invest? Update : Have questions beyond compound vs. SmartAsset can help. So many people reached out to us looking for tax and long-term financial planning help, we started our own matching service to help you find a financial advisor. The SmartAdvisor matching tool can help you find a person to work with to meet your needs. Then the program will narrow down your options to three fiduciaries who suit your needs.

You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. The more frequently interest is compounded, the more rapidly your principal balance grows. Simple interest works differently than compound interest. Simple interest is calculated based only on the principal amount. Earned interest is not compounded—or reinvested into the principal—when calculating simple interest.

The earned interest would not be added back into the principal. Simple interest is commonly used to calculate the interest charged on car loans and other forms of shorter-term consumer loans. When calculating compound interest, you need to understand a few key factors. Each plays its own role in the end product, and some variables can drastically impact your returns. Here are the five key variables involved in understanding compound interest:.

There are a few ways to calculate compound interest. The easiest way is to have an online calculator do the math for you. This gives you the daily, monthly or annual average interest rate, depending on compounding frequency. The account is compounded monthly for 10 years. Compound interest and compounding can supercharge your savings and retirement potential.

Successful compounding lets you use less of your own money to reach your goals. However, compounding can also work against you, like when high-interest credit card debt builds on itself over time. I'm a freelance journalist, content creator and regular contributor to Forbes and Monster.