What does "compound interest" mean?

Compound interest refers to the process of calculating interest on both the initial principal and the accumulated interest from previous periods. This means that each time interest is calculated, it is applied not only to the original sum of money but also to any interest that has already been added to it.

For example, if you invest a certain amount of money, the interest earned in the first period is added to the principal. In the next period, interest is calculated on the new total (the original principal plus the interest from the previous period). This leads to exponential growth of the investment over time, as the interest essentially earns interest.

This concept is a fundamental principle in finance and investing, as it highlights how money can grow faster with compound interest compared to simple interest, which is calculated solely on the initial principal. Understanding this distinction is crucial for making informed decisions about savings and investments.