Compound vs Simple Interest
See how compound and simple interest differ—and why compounding is so powerful for your money.
Simple Interest
Simple interest is calculated only on the original amount (the principal). The formula is:
Simple Interest = Principal × Rate × Time
For example, if you invest $1,000 at 5% simple interest for 3 years, you earn:
$1,000 × 0.05 × 3 = $150 in interest.
Compound Interest
Compound interest is calculated on the principal and also on any interest earned previously. The formula is:
Compound Interest = Principal × (1 + Rate)Time - Principal
For the same $1,000 at 5% compounded annually for 3 years:
$1,000 × (1 + 0.05)3 - $1,000 = $157.63 in interest
Comparison Table
| Year | Simple Interest ($) | Compound Interest ($) |
|---|---|---|
| 1 | 50 | 50 |
| 2 | 100 | 102.50 |
| 3 | 150 | 157.63 |
Takeaway: Compound interest grows your money faster, especially over long periods.