What does compound interest entail?

Compound interest refers to the process of calculating interest not only on the principal amount invested or borrowed but also on the interest that accumulates over time. This means that as interest is added to the principal, the subsequent interest calculations are based on a larger amount. Essentially, compound interest allows for the growth of an investment or loan to accelerate over time, making it more advantageous than simple interest, which only accounts for the principal.

By accumulating interest on the previously earned interest, the total amount grows at a faster rate, especially as time progresses and the effect of compounding becomes more significant. This principle is a crucial factor in finance and investing, as it highlights the potential for exponential growth in savings and investments over longer periods. Understanding this concept can help individuals make more informed financial decisions regarding savings accounts, investments, and loans.