Terry: You should be ashamed that you have made it to age 25 without understanding this, but at least you are smart enough to ask!
Compound interest is the interest you earn on the interest you have already earned, and it is a very powerful "tool"….
Say you deposit $100,000 in an Account that pays 10%….
For the first year you leave that money there, you will be paid $10,000 in interest…
For the second year, you will earn $10,000 on your original $100,000 PLUS $1,000 more on that $10,000 in interest….
For the third year, you will be earning 10% on the $100,000 AND the $10,000 AND the $1,000….
And so on….
That, in a nutshell, is what "compounding" is….
there is simple interest and compound and as each description indicates how it is figured
simple is simply interest on te $2500 at the rate stated, with each period of time, ie. if it 5% then 5% of 2500 would be added to the account
but compounding is building on top of the first, so to speak
ie the 5% interest is added to the $2500 and then that amount is figured at the 5% so the basis changes each time period
Interest rates are so low in recent years that I wouldn't waste much thought on it.
COMPOUND interest means you get interest not just on the money you put in, but also on interest you've already earned that is still in your account.
Under compound interest scheme you get interest to interest. For example If 4 % interest is allowed on Savings Bank account, first year for 2500/ you will get 100 making the amount to 2600 next you will get 104., the amount will be 2704/ If you deposit the amount on long term basis, you may get more interest
You get interest on the interest. Let's say you put $1 000 in the bank. The bank will pay interest on that $1 000. At the end of a year, because of interest, you now have $1 010 in the bank. The bank will now pay interest on the $1 010 instead of only the $1 000 you originally deposited.
Up 'til about 20 years ago, banks used to pay people to keep their money there. Imagine that. The money paid to a person was a percentage of the money that the person had kept there, and the calculation was done periodically.