What is Compound Interest and How Does It Work?

When you invest or put money into an asset or account that accrues interest, you can actually earn interest on that interest. This is known as compound interest, and it’s one of the simplest concepts in finance.

How Compound Interest Works

To learn about compound interest, let’s look at how it works in a simple savings account.

With a savings account, you’ll earn interest each month based on your agreed-upon APY. For instance, if you have a 1% APY, you’ll earn around .0833% interest a month.

Say you put $1,000 into a savings account with a 1% APY. You’ll earn about 83 cents in interest after one month. This will leave you with a balance of $1000.83. The next month, however, you’ll earn interest on this balance of $1000.83 and not the original balance of $1000, leaving you with a balance of $1001.67.

In this instance, your interest has compounded and essentially became a part of your total balance. It will do this every time you earn interest, allowing your interest to earn interest.

Savings and money market accounts, some bonds, and alternative investments like those featured on Percent all allow your interest to compound. Equities are notable for not accruing interest, only increasing or decreasing in gains based on the original principal investment.

How Compound Interest Works on Percent

Like the above example, interest also compounds on Percent notes. The amount of interest you earn each month during a note’s duration earns interest itself the following month until you roll over your investment to another note or opt to liquidate and cash out your funds.

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