How to Calculate Compound Interest: Formula, Examples & Tips
Compound interest is one of the most powerful forces in personal finance. Whether it's growing your investments or costing you money on debt, understanding how it works — and how to calculate it — can transform your financial decisions.
What is Compound Interest?
Compound interest means you earn interest on your interest, not just on the original principal. Each period, your interest is added to the balance, and the next period's interest is calculated on the new, larger balance.
Simple interest: $1,000 at 10%/year = $100/year always.
Compound interest: $1,000 at 10%/year = $100 year 1, $110 year 2, $121 year 3...
The Compound Interest Formula
Where: A = Final amount | P = Principal | r = Annual interest rate (decimal) | n = Compounding periods per year | t = Time in years
Example: $10,000 at 7% for 20 years (compounded annually)
A = $10,000 × (1 + 0.07/1)^(1×20) = $10,000 × (1.07)^20 = $10,000 × 3.8697 = $38,697
That's $28,697 in interest on a $10,000 investment!
Compounding Frequency Matters
| Frequency | $10,000 @ 6% for 10 years |
|---|---|
| Annually (n=1) | $17,908 |
| Quarterly (n=4) | $18,061 |
| Monthly (n=12) | $18,194 |
| Daily (n=365) | $18,221 |
More frequent compounding = slightly more interest. Daily vs annual is a ~1.7% difference over 10 years.
The Rule of 72
Quick mental math: divide 72 by your interest rate to estimate when your money doubles.
- 6% rate → 72 ÷ 6 = 12 years to double
- 8% rate → 72 ÷ 8 = 9 years to double
- 12% rate → 72 ÷ 12 = 6 years to double
Compound Interest on Debt
The same math that builds wealth also works against you on debt. Credit cards at 20–24% APR compound monthly, meaning unpaid balances grow rapidly:
$5,000 credit card at 22% APR — if you only pay the minimum, it could take 20+ years and cost over $10,000 in interest to pay off.
Key takeaway: Compound interest rewards savers and punishes debtors. Pay down high-interest debt aggressively, and invest consistently early.