# How does compound interest work?

> Compound interest means you earn interest on your interest, so money grows faster the longer you leave it invested.

Source: https://www.walletprep.com/learn/compound-interest/ · Updated 2026-10-01 · Investing

Compound interest means you earn interest on your interest, so your money grows on a bigger base each year. The longer it has to work, the more of your final balance comes from growth instead of from what you put in.

## Key facts
- **Growth earns growth.** Each year's interest or return is added to the balance. Next year, you earn on the original amount plus everything it already earned. That snowball effect is compounding.
- **Time matters more than the amount.** Money saved in your 20s has decades to compound. In the examples on this page, starting 10 years earlier more than doubles the balance at 65, with only $24,000 more put in.
- **Returns are assumptions.** Savings accounts pay a stated rate that can change. Investments like stock index funds have no set rate. Their returns vary from year to year and can be negative. The examples here assume a steady rate to show the math.
- **The rule of 72 gives a quick estimate.** Divide 72 by the yearly rate to estimate how many years it takes money to double. At an assumed 6% a year, 72 ÷ 6 = 12 years.

## Simple interest vs compound interest
Simple interest is paid only on the money you put in. Put $1,000 in at 7% simple interest and you earn $70 every year. After 10 years you have $1,000 + 10 × $70 = $1,700.
Compound interest is paid on the balance, which includes past interest. At 7% a year, compounded monthly, the same $1,000 grows to about $2,010 in 10 years. Year 1 adds about $72, and by year 10 each year adds well over $100, because the base keeps getting bigger.
The same math works against you on debt. A credit card balance you don't pay off compounds too, which is why high-interest debt usually comes before investing.

## Interest and returns are not the same thing
A savings account or certificate of deposit pays interest at a stated rate. The rate on a savings account can change, but the balance doesn't drop.
Stocks and stock funds don't pay a set rate. Their value goes up and down, and some years it falls. When people say an investment compounds, they mean gains are left in to grow along with the original money. Over long periods that can add up, but no rate is promised, and any single year can be a loss.
When you see a long-term projection, treat the rate as a guess. This page assumes 7% a year for most examples. That is an assumption for teaching, not a forecast, and it is before inflation, taxes and fees.

## Why starting early matters so much
Compounding is slow at first. In the first year of saving $200 a month at an assumed 7%, growth adds less than $80. The big gains come late, when the balance is large and has had decades to build.
That is why the years you give it matter more than any one deposit. Someone who starts at 25 and someone who starts at 35 may save the same $200 a month. The earlier start gets 10 more years of compounding on top, and those last years are when growth is largest.
Starting late still works. It means saving more each month to reach the same place, so the best time to start is with whatever you can afford now, even $25.

## The rule of 72
To estimate how long money takes to double, divide 72 by the yearly rate. At 8% it is 72 ÷ 8 = 9 years. At 4% it is 72 ÷ 4 = 18 years.
It is a shortcut, not exact math, but it is close for rates between about 4% and 10%. The table on this page compares the estimate with the exact answer.

## Inflation, fees and taxes
Prices tend to rise over time, so a dollar in 30 years will buy less than a dollar today. A projection of $250,000 in 30 years is worth less in today's money. The real return is roughly your return minus inflation.
Fees and taxes also come out of growth. A fund fee of 1% a year sounds small, but it is taken every year from a growing balance, so it compounds against you. Tax-advantaged accounts, such as a 401(k) or IRA, can delay or avoid some taxes on growth. The rules depend on the account and your income, so check IRS guidance for your situation.

## A worked example: starting at 25 vs starting at 35
Sam is 25 and can invest $200 a month. Sam wants to know what waiting until 35 would cost. Both cases assume 7% a year, compounded monthly. Real returns vary and can be negative.

- Assumed yearly return: 7%
- Start at 25: 480 × $200: $96,000
- Growth to age 65: $428,963
- Balance at 65, starting at 25: = $524,963
- Start at 35: 360 × $200: $72,000
- Growth to age 65: $171,994
- Balance at 65, starting at 35: = $243,994
- Balance starting at 25: $524,963
- Balance starting at 35: −$243,994
- Cost of waiting 10 years: = $280,969

1. From 25, Sam makes 480 deposits of $200, or $96,000. At 7% that grows to about $524,963 by 65.
2. From 35, Sam makes 360 deposits, or $72,000, and reaches about $243,994.
3. Waiting costs $524,963 − $243,994 = $280,969, though Sam put in only $24,000 less.

### Saving $200 a month at an assumed 7% a year, before inflation

| Year | You put in | Growth | Balance |
| --- | --- | --- | --- |
| 1 | $2,400 | $79 | $2,479 |
| 10 | $24,000 | $10,617 | $34,617 |
| 20 | $48,000 | $56,185 | $104,185 |
| 30 | $72,000 | $171,994 | $243,994 |
| 40 | $96,000 | $428,963 | $524,963 |

### Balance at 65 from $200 a month at an assumed 7%, by starting age

| Start at age | You put in | Balance at 65 |
| --- | --- | --- |
| 25 | $96,000 | $524,963 |
| 30 | $84,000 | $360,211 |
| 35 | $72,000 | $243,994 |
| 45 | $48,000 | $104,185 |

### $200 a month for 30 years at different assumed returns

| Annual return | Balance after 30 years | Of which growth |
| --- | --- | --- |
| 0% | $72,000 | $0 |
| 4% | $138,810 | $66,810 |
| 6% | $200,903 | $128,903 |
| 8% | $298,072 | $226,072 |

### Rule of 72 estimate vs exact years to double

| Annual return | Rule of 72 estimate | Exact years to double |
| --- | --- | --- |
| 2% | 36.0 years | 35.0 years |
| 4% | 18.0 years | 17.7 years |
| 6% | 12.0 years | 11.9 years |
| 7% | 10.3 years | 10.2 years |
| 8% | 9.0 years | 9.0 years |
| 10% | 7.2 years | 7.3 years |

## Common mistakes
- **Treating a projection as a promise.** A chart that shows steady 7% growth is a model. Real returns jump around and include losing years. Plan with a modest rate and expect the path to be bumpy.
- **Waiting until you can save a lot.** Small amounts started early often beat larger amounts started later, because time does much of the work. Start with what you can and raise it when your pay goes up.
- **Pulling money out after a drop.** Selling after the market falls locks in the loss and stops the compounding on that money. Long-term money should be money you won't need for many years, so you can wait out bad stretches.

## Questions people ask
### How much will $10,000 grow in 20 years?
It depends on the return, which is not known in advance. At an assumed 7% a year, compounded monthly, $10,000 left alone grows to about $40,387 before inflation. At 4% it grows less, and in a bad stretch it could be worth less than you put in.

### How often does interest compound?
It depends on the account. Many savings accounts compound daily or monthly and pay monthly. The APY on a savings account already includes compounding, so you can compare accounts by APY without working out the frequency.

### Is compound interest good or bad?
Both. It helps you when you save or invest, and it hurts you when you carry a balance on a credit card or loan. Paying down high-interest debt stops compounding from working against you.

### What is a realistic rate of return to assume?
Nobody knows future returns. Many people test a range, for example 4%, 6% and 8%, to see how much the result can change. Use the calculator on this page to try lower and higher rates.

## Do this today
Open the compound growth calculator on this page and enter what you could invest each month and your years until 65. Try 4% and 7% to see the range, then set up one automatic contribution, even $25, to a retirement account.

## Sources
- [Investor.gov (SEC): Compound interest calculator](https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator)
- [Investor.gov (SEC): Introduction to investing](https://www.investor.gov/introduction-investing)
- [FINRA: Investing basics](https://www.finra.org/investors/investing/investing-basics)

_General education, not personalized financial, tax or legal advice. Figures are examples. Check current rates and limits before you act._