See how your investments grow over time with the power of compounding. Adjust your initial investment, monthly contributions, and return rate to project long-term growth.
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Compound interest is one of the most powerful concepts in finance. Unlike simple interest, which is calculated only on the original principal, compound interest is calculated on both the initial principal and the accumulated interest from previous periods. This means your money earns interest on its interest, creating a snowball effect that accelerates growth over time.
For example, if you invest $10,000 at a 10% annual return, you earn $1,000 in the first year. In the second year, you earn interest on $11,000 instead of just $10,000, giving you $1,100. Each subsequent year, the amount of interest earned grows larger because the base keeps expanding. Over decades, this compounding effect can turn modest investments into substantial wealth.
Albert Einstein reportedly called compound interest "the eighth wonder of the world," noting that "he who understands it, earns it; he who doesn't, pays it." Whether or not the attribution is accurate, the principle holds true: compounding is the foundation of long-term wealth building.
For traders and investors, compound interest is not just a theoretical concept -- it has practical implications for portfolio growth. When you reinvest your trading profits rather than withdrawing them, each successful trade contributes to a larger capital base, which in turn can generate larger absolute returns on subsequent trades. Whether you're exploring different approaches in our strategy guide or learning to validate your ideas through our backtesting tutorial, understanding compounding helps you set realistic long-term growth expectations.
Consider a trader who starts with $10,000 and achieves a consistent 2% monthly return. With compounding, their account grows to approximately $12,682 after one year -- a 26.8% annual return rather than the 24% you might expect from simple interest. Over five years, the same 2% monthly return compounds to over $32,000, more than tripling the original investment.
The key factors that amplify compounding in trading include:
The standard compound interest formula calculates the future value of an investment based on the principal, interest rate, compounding frequency, and time period:
Where:
When regular contributions are added, the formula becomes more complex. The future value of a series of regular payments (annuity) with compounding is:
Where PMT is the regular contribution amount per compounding period. This calculator handles both the initial lump sum and recurring contributions to give you an accurate projection of your investment growth.
Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. Unlike simple interest, which only grows linearly, compound interest creates exponential growth because each period's interest is added to the principal, increasing the base for the next calculation. This "interest on interest" effect is what makes long-term investing so powerful.
More frequent compounding results in slightly higher returns because interest is calculated and added to the balance more often. Monthly compounding yields more than quarterly, which yields more than annual compounding. For example, $10,000 at 10% annually compounded monthly grows to $11,047 in one year, while annual compounding yields $11,000. The difference becomes more significant over longer time periods, but beyond daily compounding the marginal benefit is negligible.
The Rule of 72 is a quick mental math shortcut that estimates how long it takes to double your money at a given annual return rate. Simply divide 72 by the annual interest rate to get the approximate number of years. For example, at a 10% annual return, your money would roughly double in 72 / 10 = 7.2 years. At 8%, it takes about 9 years. This rule works best for interest rates between 6% and 10% and provides a useful approximation for quick financial planning.
Regular monthly contributions dramatically accelerate compound growth by continuously increasing the base amount that earns interest. Even small monthly additions can have a massive long-term impact. For instance, investing $500 per month at a 10% annual return grows to over $102,000 in 10 years, where only $60,000 is from your contributions and over $42,000 is from compounded returns. The earlier and more consistently you contribute, the greater the long-term impact due to each contribution having more time to compound.
See how compounding works with real trading results. Backtest strategies and watch your returns grow over time with historical data.
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