What is compound interest? (with calculator)

How compound interest works

Compound interest is what happens when growth is added back to the pot instead of being taken out. Say you put €10,000 in an account paying 5% a year. After year one you have €10,500. In year two, the 5% is paid on €10,500, not on your original €10,000, so you earn €525 instead of €500.

That difference looks tiny at first. It isn't, given time. With simple interest, €10,000 at 5% for 10 years gives you €15,000. With compound interest, the same money grows to about €16,289, and the gap keeps widening every year after that.

The three things that decide how much you end up with are:

1. How much you put in, both at the start and every month.
2. The rate of growth you earn each year.
3. How long you leave it. This is the one most people underestimate.

A worked example with real numbers

Now look at what happens if you change only the time:

Each extra decade doesn't add the same amount; it multiplies what is already there. Someone who starts at 25 and invests €200 a month until 65 ends up with roughly twice as much as someone who starts at 35, for only €24,000 more in deposits.

The rule of 72

You don't need a calculator for a rough idea. Divide 72 by the yearly growth rate, and you get the number of years it takes for money to double:

• At 3% a year: 72 ÷ 3 = about 24 years to double.
• At 7% a year: 72 ÷ 7 = about 10 years to double.
• At 10% a year: 72 ÷ 10 = about 7 years to double.

It works the other way too. With inflation at 3%, the buying power of cash sitting still halves in about 24 years.

Where compound interest shows up

• Savings accounts. Interest is added monthly or yearly, then earns interest itself. Rates are usually low but the money is safe.
• Investments. Index funds and ETFs don't pay a fixed rate. But when gains and dividends are reinvested, they compound in the same way, just with ups and downs along the way.
• Debt. Credit cards and some loans add unpaid interest to the balance. At 20% a year, a debt you ignore doubles in under four years.

Common mistakes

• Waiting for the "right" time to start. Time in the market is the ingredient you can't buy back later. Small amounts started early often beat larger amounts started late.
• Ignoring fees. A 1.5% yearly fee compounds too, against you. On long horizons it can eat a large share of your growth. Low-cost index funds keep more of it for you.
• Forgetting inflation. A 7% return with 2–3% inflation is closer to 4–5% in real buying power. The ECB aims for 2% inflation in the eurozone over the medium term.
• Taking the growth out. Withdrawing returns each year turns compound growth back into simple growth.