Compound Interest

Simple interest is paid only on the original principal. Compound interest is paid on the principal plus all the interest accumulated so far, so the balance grows on itself. The effect starts small and accelerates: the longer the money compounds, the larger the share of the final balance that comes from interest rather than your own contributions.

Two factors drive the outcome. The first is time, since the most dramatic growth happens in the later years when the balance is largest. The second is compounding frequency, because interest that is added monthly starts earning sooner than interest added once a year. The same force works against you on debt that compounds, such as an unpaid credit card balance, where interest charged on interest makes the amount owed climb.