Compound interest definition

Compound interest is a method for calculating interest earned on the combination of the outstanding principle balance, plus accumulated earned interest. The impact of compounding will depend on the compounding time period such as daily, monthly or annually. Obviously, daily compounding produced a greater return than annual compounding.

For example, if a $10,000 financial contract (loan or deposit) has a compound interest rate of 6% per annum, the interest earned would be $600, resulting in a year-end balance of $10,600. If all of that is rolled into a second year of compounding, the second year yield would be would be $636, including $36 of earnings on the previous year's interest earned and left in the instrument. The new two-year total would be $11,236.

With interest compounded annually at 10%, any instrument with the earnings left to compound will only take 7 years for the original investment to double. It has been said that when Albert Einstein was asked what is the most powerful force in nature, he answered, "Compound interest."