What Is Compound Interest?

Compound interest is a type of interest which is calculated by the principal, or initial investment, and also by the accrued interest, the amount of interest earned since the last interest payment. This is a different concept from simple interest, where the interest is only based upon the initial principal. This results in the investor having more money in the end.

To test out this concept, try this sample problem:

If Bob has $100 in his savings account, which will be compounded at an interest rate of 10% a year, how much money will he have in his account by the third year?

There is an equation to help figure this out, but since many people do not know it off-hand, there are many websites that will do the work for you. Putting this information into an online Compound Interest calculator like the one at moneychimp.com will give you the correct answer of $133.10, making it much easier to figure out how much compound interest your investment will earn.

Sources: http://www.investorwords.com/1013/compound_interest.html
http://www.moneychimp.com/calculator/compound_interest_calculator.htm
http://dictionary.bnet.com/definition/accrued+interest.html