What is compound interest?

Compound interest is a financial concept that refers to the process of earning interest not only on the initial principal amount but also on the interest that has already been added to that principal over time. This means that as you save or invest money, you earn interest on the money you put in plus any interest that has previously been credited to your account. Over time, this can lead to significant growth of your savings or investments due to the effect of compounding.

For instance, if you deposit $1,000 into a savings account that offers an annual interest rate of 5%, at the end of the first year, you'll earn $50 in interest. In the second year, you'll earn interest on $1,050 (the original amount plus the interest earned), which results in earning interest on your interest. This compounding effect can significantly increase your total savings over the long term, making it a powerful tool for wealth accumulation.

Understanding compound interest is crucial in financial literacy because it impacts saving strategies, investment decisions, and the way individuals grow their wealth over time.