Compound interest is often called the eighth wonder of the world — and for good reason.
It’s interest on interest: your balance earns returns, and those returns go on to earn their own returns.
Over time, the growth curve bends sharply upwards — a snowball effect for your savings and investments.
Table of contents
- What is compound interest?
- The compound interest formula
- Worked example
- Visualising compound growth
- Try it with your own numbers
- Common mistakes to avoid
- How to maximise compounding
- The bottom line
- FAQs
What is compound interest?
With simple interest, you only earn returns on your original deposit.
With compound interest, you earn on both your starting balance and the interest already earned.
That’s what makes compounding powerful — it converts time into your biggest ally.
The longer you stay invested, the faster the growth accelerates, even if your contributions don’t change.
The compound interest formula
FV = P × (1 + r/n)^(n × t)
Where:
- FV – future value (what you’ll have at the end)
- P – starting amount (principal)
- r – annual interest rate (as a decimal, e.g. 6% → 0.06)
- n – number of compounding periods per year (e.g. 12 for monthly)
- t – time in years
Each compounding period adds new earnings to your balance — and the next round of interest is calculated on that bigger amount.
Worked example
Say you start with $5,000, add $100 each month, and earn 6% per year, compounded monthly, for 10 years.
| Detail | Value |
|---|---|
| Total contributions | $17,000 |
| Final balance | ≈ $23,500 |
| Growth from compounding | ≈ $6,500 |
That extra $6,500 didn’t come from extra deposits — it came from time and consistency.
Tip: Regular contributions, even modest ones, matter far more than timing the market.
Visualising compound growth
Think of compounding like rolling a snowball down a hill.
At first, it’s slow and small, but each turn adds more snow and momentum.
The early years look flat, but later growth dominates — the final stretch often adds more value than all previous years combined.
Try it with your own numbers
Use the free Compound Interest Calculator to project your savings growth.
Adjust the interest rate, timeframe, and contributions to see how each affects your final balance.
For a realistic view of purchasing power, choose an after-inflation (“real”) return.
Common mistakes to avoid
- Ignoring fees: management or fund costs above 1% can significantly reduce compounding benefits.
- Pausing contributions: missing months breaks the rhythm. Automate transfers to stay consistent.
- Chasing high returns: steady, reliable growth compounds better than volatile bets.
How to maximise compounding
- Start early – every extra year multiplies results.
- Reinvest earnings – keep dividends or interest in the account.
- Increase deposits gradually – even small annual rises compound strongly.
- Stay invested – time in the market beats timing the market.
The bottom line
Compound interest rewards patience and consistency.
You don’t need a finance degree — just a plan, regular deposits, and time.
Start small, stick with it, and let compounding do the heavy lifting.
“The best time to start was 20 years ago. The second-best time is today.”
Next step: explore the Compound Interest Calculator and see how quickly your savings can grow.
FAQs
What is compound interest in simple terms?
It’s interest on both your original money and the interest that’s already built up.
How often is interest compounded in Australia?
Usually monthly for savings accounts; some investments use quarterly or annual compounding. Check your product disclosure statement for details.
Is compound interest taxable?
Yes. Interest from savings or investments is part of your assessable income and taxed at your marginal rate, unless held inside superannuation.
Which is better — monthly or annual compounding?
Monthly or quarterly generally yields slightly higher returns, as interest is added more frequently.
How can I calculate it easily?
Use the Compound Interest Calculator. It applies the formula automatically and shows your projected balance.
Can compounding work against you?
Yes. With debt, compound interest accelerates what you owe if you don’t make repayments — especially on credit cards. Clear high-interest debts first before focusing on investing.
Disclaimer: This article is general information only and does not constitute financial advice. Past performance is not a reliable indicator of future results.