# What is the value of compound interest?

Compound interest can have a dramatic effect on the growth of an investment. Use this interest calculator to illustrate the impact of compound interest on the future value of an asset.

## Compound Interest Explained

When you buy an investment, it’s not just the interest rate that matters, but also how that rate is calculated. Compound interest allows you to earn interest on interest, allowing you to get more — sometimes much more — for your initial investment.

## What Is Compound Interest?

Compound interest can be explained fairly easily. There are two ways to earn interest. Simple interest stays the same for as long as you are investing. If you invest \$1,000 at 7% with simple interest, calculated yearly, your investment will earn \$70 the first year, \$70 the next year and \$70 every year after that.

With compound interest, the amount you earn is added to your principal, and interest is calculated on that. If you invest \$1,000 at 7%, calculated yearly, you will earn \$70 the first year. The second year, you will earn 7% on \$1,070 (not \$1,000) so you will earn \$74.90. This can quickly add up.

## How Much Can I Earn With My Investment?

You can earn a great deal with compound interest, especially if you keep your money in your investment vehicle for a long time and don’t remove it. The way your compound interest is calculated also matters. Some investments pay out interest yearly, but some pay monthly, quarterly, daily or in other increments. This will also determine how much you earn, as will your interest rate.

You can determine how much you will earn with this formula:

The principal you invest(1+interest rate/compound periods annually) compounding periods annually)x(number of years)

If you invest \$1,000 at 7%, compounded annually, for five years, the formula would look like this:

1000(1+0.07/1)1×5

You can use this formula to determine whether an investment will yield more. For example, will an investment that pays 5% but compounds quarterly make more than an investment of the same amount at 6% but calculated yearly? Some of the answers will depend on how long you can keep your money in the investment vehicle before you will need it, and this formula can help you make the right choice.