Question 1

What is compound interest?

Accepted Answer

Compound interest is interest earned on both the initial principal and on previously accumulated interest. Unlike simple interest (which only calculates on the principal), compound interest creates a snowball effect where your money grows exponentially over time. Albert Einstein reportedly called it "the eighth wonder of the world."

Question 2

How does compounding frequency affect returns?

Accepted Answer

More frequent compounding produces slightly higher returns. $10,000 at 8% for 10 years yields: annually = $21,589; quarterly = $22,080; monthly = $22,196; daily = $22,253. The difference between monthly and daily compounding is small, but annually vs. monthly is meaningful over long periods.

Question 3

What is the Rule of 72?

Accepted Answer

The Rule of 72 is a quick way to estimate how long it takes to double your money. Divide 72 by the annual interest rate. At 8% interest, your money doubles in approximately 72/8 = 9 years. At 12%, it doubles in about 6 years. This only works for reasonable rates (2-20%).

Question 4

What is the difference between simple and compound interest?

Accepted Answer

Simple interest is calculated only on the principal: Interest = P x r x t. Compound interest is calculated on principal plus accumulated interest. Over short periods, the difference is small. Over long periods, it becomes enormous — $10,000 at 8% for 30 years grows to $34,000 with simple interest but $100,627 with monthly compounding.

Question 5

What is the effective annual rate?

Accepted Answer

The effective annual rate (EAR) is the actual yearly return after accounting for compounding. A 12% nominal rate compounded monthly has an EAR of 12.68%. This is the true rate you earn or pay, and it allows fair comparison between products with different compounding frequencies.

Question 6

How does compound interest apply to debt?

Accepted Answer

Compound interest works against you with debt — unpaid interest compounds and increases the balance. Credit card debt at 20% APR compounded daily can grow rapidly if only minimum payments are made. This is why paying off high-interest debt should typically be prioritized over low-yield investments.

Question 7

When should I start investing to benefit from compound interest?

Accepted Answer

As early as possible. Time is the most powerful factor in compound interest. Starting at age 25 with $200/month at 8% yields about $702,000 by age 65. Starting at 35 with the same investment yields only $298,000 — ten fewer years of compounding costs over $400,000.

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