Simple interest is paid only on the money you put in. Compound interest is paid on your money plus the interest it has already earned, so each period's interest is a little bigger than the last. Over a few years the difference is small; over decades it becomes enormous.
The formula
A = P × (1 + r/n)n×t
- A is the final amount
- P is the starting principal
- r is the annual rate as a decimal (6% = 0.06)
- n is the number of compounding periods per year
- t is the number of years
A worked example
$10,000 at 6%, compounded annually:
| Year | Interest that year | Balance |
|---|---|---|
| 1 | $600 | $10,600 |
| 2 | $636 | $11,236 |
| 3 | $674 | $11,910 |
| 10 | $1,014 | $17,908 |
| 30 | $3,251 | $57,435 |
With simple interest the balance after 30 years would be $28,000. Compounding doubles it.
Adding regular deposits
Most people save monthly rather than in one lump. Each deposit starts compounding from the day it goes in, so early deposits do far more work than late ones. The calculator handles this for you.
Why time beats rate
Someone who invests $200 a month from 25 to 35 and then stops can end up with more at 65 than someone who invests $200 a month from 35 to 65, at the same return, because the early money has decades longer to compound.
Compounding works against you too. Credit card balances compound at around 20% a year. Paying off high-interest debt is usually the best "return" available.
Frequently asked questions
What is the difference between simple and compound interest?
Simple interest is calculated only on the original amount. Compound interest is calculated on the original amount plus accumulated interest.
Where can I earn compound interest in Canada?
High-interest savings accounts, GICs and investments held in accounts such as a TFSA, RRSP or FHSA, where reinvested returns compound over time.