Compound Interest vs. Simple Interest
Both forms of interest are quoted as a percentage of the amount you deposit, but they behave very differently over time. Understanding the gap between them is the first step toward making compound interest work in your favor.
Simple interest: interest on the principal only
Simple interest is calculated only on the original principal — never on the accumulated interest. If you deposit $10,000 at 5% simple interest for 10 years, you earn $500 of interest every single year ($10,000 × 0.05), and after a decade you have $15,000. The yearly dollar amount never changes, so the growth curve is a straight line.
Compound interest: interest on the principal plus prior interest
Compound interest recalculates each period's interest on the current balance — principal plus everything you've already earned. Applying the same $10,000 at 5%, compounded annually for 10 years, leaves you with about $16,289 — roughly $1,289 more than simple interest produced, just by reinvesting the interest. Monthly compounding pushes the final figure slightly higher still.
A side-by-side worked example
| Year | Simple interest balance | Compound interest balance* |
|---|---|---|
| 1 | $10,500 | $10,500 |
| 5 | $12,500 | $12,763 |
| 10 | $15,000 | $16,289 |
| 20 | $20,000 | $26,533 |
| 30 | $25,000 | $43,219 |
*Annual compounding at 5%. $10,000 starting principal, no additional contributions.
Why the gap gets wider over time
Under simple interest, every year adds a constant dollar amount — the same flat $500 in the example above. Under compound interest, every year adds interest on a growing balance, so the yearly increment itself grows: at year 30 in the example above, compound interest adds roughly $2,150 in that single year, more than four times the simple-interest year. This is why compounding matters most on long horizons rather than short ones.
Which one applies to you?
Savings accounts, money-market accounts, CDs, bonds (when interest is reinvested), and most investment accounts earn compound interest. Some personal loans and many car loans use simple interest, which works in your favor as the borrower. The calculators on this site model compound interest because that's the regime most relevant to long-term saving — start with the compound interest calculator to see your own projection.