How Compound Interest Works
A clear explanation of compounding frequency, the rule of 72, and why starting early beats investing more later.
Compound interest is interest calculated on both the original principal and the interest already accumulated — meaning your money earns returns on its returns. Over long periods, this effect can dramatically outweigh simple, non-compounding growth.
The compound interest formula
A = P(1 + r/n)nt, where P is the principal, r is the annual interest rate, n is the number of times interest compounds per year, and t is the number of years.
Why compounding frequency matters
The more frequently interest compounds — annually, quarterly, monthly, or daily — the faster your money grows, because each compounding period adds interest on a slightly larger base. The difference between annual and monthly compounding is small over short periods but becomes meaningful over decades.
The Rule of 72
A quick mental shortcut: divide 72 by the annual interest rate to estimate how many years it takes for an investment to double. At 8% annual growth, money roughly doubles in 9 years (72 ÷ 8); at 12%, in about 6 years.
Time matters more than timing
Because compounding accelerates over time, starting to invest early — even with smaller amounts — usually outperforms investing larger amounts later. This is the central argument for beginning SIPs or long-term investments as early as possible.