What does compound interest mean?

Compound interest refers to the process where interest is calculated not only on the initial principal amount but also on any interest that has previously been added to it. This means that each period, the interest accrued is added to the balance, and future interest calculations are based on this larger amount. As a result, the investment can grow at an accelerating rate over time, as interest earns interest.

This concept contrasts with simple interest, which is calculated solely on the principal and does not take into account the interest that accumulates over previous periods. Therefore, the ability of compound interest to generate returns on returns is a key advantage in personal finance, especially for investments held over long periods. This characteristic makes compound interest a powerful tool for growing savings and investments.