compound interest

noun

Definition of compound interest

: interest computed on the sum of an original principal and accrued interest

Examples of compound interest in a Sentence

Recent Examples on the Web

In the recent past, individuals depended on the financial power of compound interest to take an amount of money and greatly increase it over time to reach goals. Erik Sherman, Fortune, "‘Bizarro World’: Behind the Normally Staid Bond Market’s Weird, Wild Summer," 23 Aug. 2019 No conversation about compound interest seems to make a difference. Michelle Singletary, Washington Post, "Should you butt out if your millennial co-worker opts not to save for retirement?," 5 Aug. 2019 In today's dollars, without further compound interest added, that would be $172 trillion. oregonlive.com, "Some white people don’t want to hear about slavery at plantations built by slaves," 8 Aug. 2019 Sure, there was a decent chunk of change, but not enough to comfortably retire and nowhere near what could’ve been there had the money been properly invested and reaping the rewards of compound interest. Erin Lowry, USA TODAY, "Millennials, you've got this all wrong. You need to stop 'saving' for retirement.," 20 June 2019 Like compound interest, these secondary beneficiaries will pass on the benefits to others, in an ever-expanding ripple. Ray D. Madoff, WSJ, "The Case for Giving Money Away Now," 16 June 2019 Math Investors often miscalculate compounding interest. Shlomo Benartzi, WSJ, "If You Don’t Save Enough, Perhaps You Have ‘Exponential Growth Bias’," 16 June 2019 That's especially true with money, since time can be one of your greatest assets, allowing you to ride out the ups and downs of the markets and benefit from compounding interest and market growth. Samantha Leach, Glamour, "The Only Money Hacks You Need to Save Big in 2019," 14 Jan. 2019 The tricky thing is that fertility rates work like compound interest, where a small difference in interest rate can add up to a huge difference over time. Cathleen O'grady, Ars Technica, "To understand population growth, culture matters," 7 Aug. 2018

These example sentences are selected automatically from various online news sources to reflect current usage of the word 'compound interest.' Views expressed in the examples do not represent the opinion of Merriam-Webster or its editors. Send us feedback.

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First Known Use of compound interest

1660, in the meaning defined above

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Last Updated

13 Sep 2019

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The first known use of compound interest was in 1660

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More Definitions for compound interest

compound interest

noun

Financial Definition of compound interest

What It Is

Compound interest is interest earned on principal plus interest that was earned earlier.

How It Works

Let's assume you have $100 to open a savings account at XYZ Bank on January 1. The annual interest rate is 5%. How much will you have in five years?

Well, if the bank simply gave you 5% of your $100 at the end of the year, you would have $105 on December 31. If you left the $105 in the account to earn another 5% next year, at the end of that second year, you would have: $105 x 1.05 = $110.25. Not only did you earn interest on your original $100 in year two, you earned interest on year one's interest. That is, it compounded. If you carried this out another eight years, here's what your account might look like:

At the end of 10 years, you would have $162.89 in the account just for doing nothing. But it gets better. The example above assumes the bank pays interest on the balance at the end of the year (that is, the interest compounded annually). In the real world, a bank would usually pay you interest on your account balance at the end of every month (that is, the interest compounds monthly). The bank simply divides the annual interest rate (5% in our case) by 12 months, and applies that rate to your balance at the end of each month. So in year one, let's see what happens:

Notice that when the bank compounded the balance annually, you only had $105 at the end of year one. But if the bank compounds monthly, you have $105.12 at the end of year one. It may not sound like much, but consider the effect on a $500,000 beginning balance: At the end of 10 years, the investor has $814,447.13 if the interest compounds annually, but she has $823,504.75 -- a full $9,057.62 more -- if the interest compounds monthly.

It is important to note that compounding doesn't just affect how much interest investors earn; it affects how much interest investors pay. For example, if that $1,000 savings account had really been a $1,000 loan to you from XYZ Bank, the amount of interest you pay would be influenced by how often the bank compounded the rate. The important lesson here is that the more frequently compounding occurs, the more interest is earned (or paid) on a balance. Some credit cards even compound interest daily, which greatly affects the borrower's balance owed.

Why It Matters

The financial world often refers to compound interest as "magic" because it is one of the most fundamental ways to build wealth yet takes the least amount of effort. But because of the variety of interest calculation methods out there, borrowers should compare lender offers, and investors should compare investment offers by carefully reading the disclosure accompanying those offers. Investors are well served to understand how an institution’s choice of interest-calculation methods affect the amount of interest applied to the investor’s account. Depending on the anticipated activity, the borrower might save money and the investor might make more money by preferring one calculation method to another.

This InvestingAnswers story features a real-life example of how compounding can work for you: How One Normal Lady Turned $200 into $7 Million.

Source: Investing Answers

compound interest

noun

English Language Learners Definition of compound interest

finance : interest paid both on the original amount of money and on the interest it has already earned

compound interest

Legal Definition of compound interest

see interest sense 5

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