What is Compound Interest? Compound Interest Formula Explained

So you wanna build wealth. You’ve come to the right place. At WealthStack, we’re in the business of helping minorities, women, and veterans learn how to take control of their finances in order to be the wealth-builders they’re destined to be. That you? Of course it is.

Now, before you learn how to compound your wealth, you have to learn how to build it. Then you'll be able to understand is how interest works. In fact, if you’re lookin’ for lots of financial security in the future, you must have a system set in place that helps you grow your cash. Compound interest is one way to do this and help you earn more on your savings or investments.

Let’s walk you through the benefits of compound interest and how to calculate it.

What Is Compound Interest And How Does It Work?

Compound interest is interest added to another interest. Got it? Good. End of lesson. Nah, we’re just kidding. It’s a bit more complicated than that.

Compound interest is the interest that accumulates on both the principal amount and the interest on it. But here, let me paint a clearer picture to help you understand it better.

For example, let's say you have $1000 in the bank that earns you an annual interest of 5%...

  1. In the first year, you earn 5% of $1000, which is $50, giving you a balance of $1050.
  2. In the second year, you would earn 5% of the new balance ($1050), which is $52.5. Add that onto your existing balance, and your new balance adds up to $1,102.50. 
  3. In the third year, you would earn a 5% interest of $1,102.50, which is equal to $55.125, increasing your balance to $1,157.625. In the next year, you get 5% of the new balance in your account, and so on. 

Basically, your interest now earns interest!

Compound Interest Formula Explained

Learning how to really build and compound wealth means finding these little “loopholes” (they’re not massive secrets, actually, you just have to know what to look for). If you think you’re going to get rich off of putting money into a savings account, then we’re sorry to have to break the bad news to you. Everybody from Kanye to J Balvin invests in something, and you can start small by figuring out how compound interest could work in your favor.

With compound interest, you're not just going to earn money with your original deposit alone. As mentioned, even your interest earns interest. But, the amount of compound interest you can earn depends on the principal amount, interest rate, time, and the number of times the interest is compounded. Compound interest is calculated using this formula:

    A = P (1 + r/n)nt


  • A = final amount you get paid
  • P = principal investment
  • r = interest rate (in decimal)
  • n = number of times the interest is applied within the period
  • t = time

For example, let’s say you save up a ton of money and put $5,000 into a savings account with an interest rate of 5%. Let’s also assume that the interest is compounded monthly. What could you have in the bank after 10 years?

  • P = 5000
  • r  = 5/100 (0.05)
  • n = 12
  • t = 10

If we fix these figures into the formula for compound interest, we get:

A= 5000x (1+0.05/12)(12x10) 

Math, not your thing? We’ll do the calculations for you. After 10 years, the investment balance will be $8235.05.

Why Compound Interest is So Powerful

You don’t really have to understand the compound interest formula in-depth to know that compound interest is a faster way to grow your wealth than just throwing cash into a regular savings account alone.

To help you understand the powerful and beneficial nature of compound interest, Warren Buffet once said:

“My wealth comes from a combination of living in America, some lucky genes, and compound interest.”

Buffet’s genes have a lot to do with his success, sure, but there’s no downplaying the significance of what compound interest can do for you, whether you’re saving big or small.

Compound interest can benefit you if you're saving or investing for the long-term, especially if it runs for decades (so start now, millennials). The best part about this whole thing is that you don’t have to do anything. You’re not playing the stock market, and you’re not investing in some wild “get rich quick” scheme (that doesn’t work). The interest on your money simply compounds and grows your savings over time.

Our Final Words

While there are lots of benefits to compound interest, it can also work against you if you’re paying off loans. That’s why student loan debt is so dangerous, and it’s why it’s crippling millions of Americans (minorities even more so).

Wanna really play the game? Download our free financial guide to get yourself up to speed on how to lead a financially healthy lifestyle. Get your credit score in check, budget like a boss, and start bulking up those savings. Because the WealthStack platform is going to take you to the next level. It’s full of free classes, tips, and top-level resources designed specifically for minorities, women, and veterans. 

Sound like your kinda thing? Click here to download the Wealth Stack app on the App Store, or here to download it on Google Play.