What is compound interest?

Compound interest is defined as interest that is calculated on the initial principal and also on the accumulated interest from previous periods. This means that as time goes on, the interest earned adds to the principal, leading to interest being calculated on a growing amount. Each compounding period, whether it be annually, semi-annually, quarterly, or monthly, the total balance increases, resulting in interest accruing at an exponential rate over time.

This characteristic makes compound interest a powerful force in finance, particularly for savings and investments, as it allows the growth of wealth to accelerate. In contrast to simple interest, which only considers the principal, compound interest leads to greater total returns over time, magnifying the benefits of saving and investing early.

In this context, other options do not accurately capture the full nature of how compound interest works or apply to different scenarios unrelated to the specific definition of compound interest.