Compound Interest Definition

What is compound interest?

Compound interest – also known as ‘compounding’ – is the return you earn on top of your investment gains by reinvesting your profits instead of withdrawing them. By reinvesting your capital gains, you’ll be increasing the total size of your investment portfolio.

Compound interest main points

Here are the main points to keep in mind about compound interest.

Growth: compound interest can result in a higher rate of investment growth over the long term compared to withdrawing your gains as income. This is because by investing your gains, it increased the total size of your investment.
Compounding frequency: the more often that your gains are compounded within a given time frame, the more you can earn. Common compounding frequencies include monthly, quarterly, semi-annually, and annually. This depends on the frequency of when interest or dividends are paid and reinvested.
Longer time horizons: compound interest is most beneficial over the long term. That’s because the longer you leave your money to compound, the more time it has to grow.
Positive and negative impact: compound interest can work in your favour when your investments are generating gains. But, it can work against you when you are paying interest on loans or credit card balances.

The Rule of 72

The Rule of 72 is often spoken about alongside compounding, and it’s a quick but by no means concrete way to estimate how long it might take for an investment to double at its current rate of return.

The formula to use is: 72 ÷ annual return %. So for example, if you’re earning 7% a year on your investments and reinventing your profits, the calculation would be 72 ÷ 7 = 10.29, which would mean your investment could double in a little over 10 years if you achieve this rate of return consistently.

Compound interest can be generated through various financial accounts and assets, including savings accounts or investments like stocks, bonds, and funds.

All investing should be long term (min. 5 years). The value of your investments can go up and down, and you may get back less than you invest.