Question 1

What is compound interest?

Accepted Answer

Compound interest is interest calculated on initial principal and accumulated interest from previous periods. Unlike simple interest (calculated only on principal), compound interest grows exponentially because you earn "interest on interest." Formula: A = P(1 + r/n)^(nt), where A is final amount, P is principal, r is annual rate, n is compounds per year, t is years. Albert Einstein reportedly called it "the eighth wonder of the world."

Question 2

How often should interest compound?

Accepted Answer

More frequent compounding yields higher returns. Common periods: Annually (once/year), Semi-annually (twice/year), Quarterly (4 times/year), Monthly (12 times/year), Daily (365 times/year), Continuously (infinite). Example: $10,000 at 5% for 10 years: Annual = $16,289, Monthly = $16,470, Daily = $16,487. Difference seems small but grows significantly over longer periods and larger amounts.

Question 3

What is the rule of 72?

Accepted Answer

The Rule of 72 is a quick way to estimate how long it takes to double your money with compound interest. Divide 72 by the annual interest rate: Years to Double ≈ 72 / Interest Rate. Example: at 6% return, 72/6 = 12 years to double. At 8%, 72/8 = 9 years. At 12%, 72/12 = 6 years. This is an approximation but remarkably accurate for rates between 6-10%.

Question 4

How does compound interest help retirement savings?

Accepted Answer

Compound interest is crucial for retirement savings because of the long time horizon (30-40 years). Starting early dramatically increases final balance. Example: Save $500/month at 7% return: Start at 25, retire at 65 (40 years) = $1,220,000. Start at 35, retire at 65 (30 years) = $567,000. The 10-year delay results in $653,000 less, despite only $60,000 more in contributions. Time is the most powerful factor.

Question 5

What is a good compound interest rate?

Accepted Answer

Good rates depend on investment type and risk tolerance: High-yield savings accounts: 4-5%, CDs: 4-5.5%, Bonds: 4-6%, Stock market (historical average): 10% (with volatility), Real estate: 8-12%, Diversified portfolio: 7-9%. Higher returns typically come with higher risk. For retirement planning, 6-8% is a reasonable long-term assumption. Inflation averages 2-3%, so real returns (after inflation) are 4-5% for balanced portfolios.

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