How compound interest works
Simple interest pays a percentage of your original deposit every period. Compound interest pays a percentage of your current balance, which includes previous interest. Each period's interest becomes next period's principal, so growth accelerates. The effect is modest over a few years and enormous over a few decades.
Put $10,000 in at 7% with no contributions and you have about $19,700 after 10 years, $38,700 after 20, and $76,100 after 30. The third decade adds more than the first two combined — the balance doubled, so the same 7% produces twice the dollars.
Contributions are the other half
For most people, regular contributions do more of the work than the starting balance. In the default example above — $10,000 start, $500 a month, 7%, 20 years — the ending balance is around $299,000. Only $130,000 of that is money you deposited. Increase the contribution and watch how the interest line responds; over long horizons, interest earned ends up larger than everything you paid in.
What rate to use
Use the APY printed on the account for savings accounts and CDs. For a diversified stock portfolio, long-run historical averages are roughly 7% after inflation or about 10% before it, with large swings year to year. For a conservative planning figure, 5%–6% is common. Compounding frequency (daily, monthly, yearly) makes a small difference; the rate and the time horizon make a big one.
Future value with contributions
FV = P(1 + r/n)ⁿᵗ + C × [ ((1 + i)ᵐ − 1) / i ]
- P = starting amount
- r = annual rate, n = compounds per year, t = years
- C = monthly contribution, m = total months
- i = effective monthly rate
Frequently asked questions
+What is the Rule of 72?
Divide 72 by your annual rate to estimate how many years it takes money to double. At 7%, roughly 10.3 years; at 4%, 18 years. It's a quick mental check on the calculator's output.
+Does compounding frequency matter much?
Less than people expect. $10,000 at 5% for 10 years grows to $16,289 compounded yearly and $16,487 compounded daily — about $200 difference. Focus on the rate and the time.
+Should I enter the return before or after inflation?
Either, as long as you interpret the result the same way. A real (after-inflation) return of 6%–7% gives you a balance in today's purchasing power, which is usually more useful for retirement planning.
+Are taxes included?
No. In a taxable account you'll owe tax on interest or gains each year or when you sell, which reduces the effective rate. In a 401(k), IRA or Roth, growth is tax-deferred or tax-free, so the calculator's result is closer to reality.