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Understanding Compound Interest

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This story is sponsored by Zions Direct. Learn more about Zions Direct.

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.