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Understanding Compound Interest

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As opposed to simple interest, which earns interest on the original principal amount only, compound interest is the interest an investor earns on his/her original investment plus the interest earned on the interest that has accumulated over time.

Suppose you deposit $10,000 into an account earning 2% interest each year for two years. In the first year, you will earn interest of $200. The second year you will earn an additional $200 interest on the $10,000 and the $200 interest earned in the first year, if reinvested, will earn interest as well and grow to $204, making the total amount of interest earned in the second year $204. While this may not appear to be much, over the years the effect of compounding interest can have a big impact on your savings.