What Is Compound Interest? Compound interest is a type of interest that is calculated not only on the initial principal amount but also on the accumulated interest over time. This means that the interest earned in each period is added to the principal amount, and the interest for the next period is calculated on the new balance. For example, let's say you deposit $1,000 in a savings account that pays 5% interest per year. At the end of the first year, you would earn $50 in interest, bringing the total balance to $1,050. In the second year, the interest is calculated on the new balance of $1,050, which means you would earn $52.50 in interest. By the end of the second year, your total balance would be $1,102.50. As you can see, the interest earned in each year is added to the principal amount, which increases the balance and leads to even more interest earned in subsequent periods. This compounding effect can be very powerful over long periods of time and can lead to significant grow