Compound Interest
Compound interest pays interest on your interest, so the gain grows every year even at a fixed rate. See how much that accelerates over a decade.
Real lesson card · Page 1 of 3
Interest that earns interest
Setup
You invest $1,000 at 8% per year, compounded annually. How does the interest change each year?- 1Year 1: 1,000 times 1.08 = 1,080. Interest earned: $80.WhyThe first year earns interest on the original $1,000 only.
- 2Year 2: 1,080 times 1.08 = 1,166.40. Interest earned: $86.40.WhyNow interest is earned on $1,080 — the interest itself is earning.
- 3Year 3: 1,166.40 times 1.08 = 1,259.71. Interest earned: $93.31.WhyEach year’s base is larger, so each year’s interest is larger.
Takeaway
The dollar amount grows every year even though the rate is fixed — that acceleration is compounding.The Rule of 72
Divide 72 by the annual percentage rate to estimate the years it takes money to double.Example
At 8%, 72 divided by 8 is 9 years to double, so $1,000 becomes roughly $2,000 in about nine years.Myth
At a fixed rate, the interest you earn each year stays the same.Reality
Each year’s interest is added to the balance, so the base grows and the next year’s interest is larger. The dollar gain rises even though the rate never changes.Recall check from the same lesson
With compound interest at a fixed rate, the dollar amount of interest earned each year stays the same.
Review the explanation
Answer: False. Interest is added to the balance each year, enlarging the base, so the next year's interest is larger — the dollar gain rises even at a fixed rate.
One sitting · 20–30 minutes
A focused session on Compound interest
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