Simple vs compound interest: a worked comparison
Understand how interest on interest changes a balance, compare simple and annual compound growth, and check contribution timing.
Updated · How we checkCompounding adds prior interest to the balance on which later interest is calculated.
Compare like-for-like assumptions
For a starting balance P, constant annual rate r and duration t years, simple interest gives P × (1 + r × t). Annual compounding gives P × (1 + r)^t when there are no contributions or withdrawals. Rates in these formulas are decimals: 5% is 0.05.
Check the compounding interval
Monthly and annual compounding produce different modeled balances when they use the same nominal annual rate. The site's compound interest calculator uses monthly periods. Enter the nominal rate expected by that tool and inspect its formula; an effective annual yield is a different rate convention.
Account for contributions and uncertainty
Money deposited at the start of a period has more time to grow than money deposited at the end. The calculator documents its contribution timing. An entered growth rate is an assumption, and fees, tax, inflation and variable returns are not automatically deducted.
Put the formula into practice
Starting balance: 1,000. Annual rate: 5%. Duration: 2 years. No contributions.
Annual compounding adds 2.50 more than simple interest in this example. Monthly compounding would give a different result.
References
Definitions and method references. Example rates and prices on this page are editable assumptions.