Compound Interest vs. Simple Interest

It’s important to understand how compound interest differs from simple interest. With simple interest, you only earn interest on your original principal. So, using the same example of $1,000 at 5% over five years:

  • Simple interest = $1,000 + ($1,000 × 0.05 × 5) = $1,250

  • Compound interest = $1,276.28 (if compounded annually)

It may not seem like a big difference at first, but over 10, 20, or 30 years, compound interest can lead to thousands more in returns.

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