What is compound interest and why should you care about it?

Compound interest is when the money that you invest makes money, and then that money makes money, and then that money makes money, and so on and forever (until you take it all out to use as spending money). If you keep investing more money, it keeps compounding. If you don’t invest more money, it keeps compounding. It’s a win-win either way.

Let’s say you invest $1,000 and it grows 10% in the first year. You now have $1,100. In year two, you earn 10% not on your original $1,000, but on the full $1,100 that you now have. So, you make $110 instead of $100 in year two. Year three? You’re earning returns on $1,210. And it keeps going.

It may seem small at first, but compounding means that it’s always adding. It doesn’t take away. So, the longer you give it, the more you’ll have. And let’s be honest, making $210 in two years without having to actually do anything isn’t exactly a negative.

Does it matter when you start?

Yes, here’s why:

Person A starts investing $200 a month at age 25. They do this for 10 years, then stop completely. They invested a total of $24,000.

Person B waits until 35 to start, then invests $200 a month for 30 years straight until they’re 65. They invested a total of $72,000 — three times as much as Person A.

Who do you think has more money at 65?

Person A. By a lot.

Even though Person A only invested for 10 years, it was 10 years sooner than Person B. When it comes to compounding, more time is better than more money invested.

This does not mean that if you didn’t start early (say in your 20s) then you shouldn’t start at all. Start today, start tomorrow, make it a New Year’s resolution, as long as you start. Playing catch-up is better than never joining the game.

The downside.

Compound interest works in reverse, too.

That credit card balance charging 22% interest? It’s compounding against you. Every month you carry a balance; you’re not just paying interest on what you originally borrowed — you’re paying interest on the interest too.

Let’s say you have a $5,000 credit card balance at 22% APR (Annual Percentage Rate), if you only make minimum payments, it could take you over 20 years to pay off and cost you more than $10,000 in interest. That’s compound interest working in reverse.

This is why high-interest debt is so brutal and why paying it off aggressively can completely change your financial picture.

A good way to avoid compound interest working against you is to pay off your total credit card balance every month.

The “boring” middle years.

The beginning is exciting – you’re starting to invest, you feel proud of yourself, it’s great!

The end is exciting – you get your money and it’s way more than you put in, that’s great!

The middle is… kind of boring. It’s underwhelming, there are no massive, dramatic leaps in dollar amounts, and you aren’t seeing the fruits of your labor (or compound interest’s labor).

If this bothers you, don’t give up, just don’t look. Seriously. If you’re only interested in seeing big progress, then pay no mind to the little progress and let compound interest continue to work in the background.

Then, somewhere around year 15, 20, 25, start paying attention. Suddenly, your account is growing faster in one year than you’re able to contribute and your investments are doing more work than you are. At this point, you’ll congratulate yourself for not being discouraged by miniscule progress early on and allowing compound interest to really shine.

The takeaway.

Compound interest is just math, but it’s math that rewards patience, consistency, and time. You don’t need a massive salary or a huge lump sum to make it work, you just need to start – and then let time do the heavy lifting.