What is compound interest?

Compound interest refers to the interest that is calculated on the initial principal as well as on the accumulated interest from previous periods. This means that with compound interest, not only does the initial amount invested earn interest, but the interest that has already been added to the principal also begins to earn interest over the following periods. This concept can lead to exponential growth of an investment over time, as the interest builds upon itself.

In contrast to some of the other options, this characteristic of accumulating interest on both the principal and previously earned interest distinguishes compound interest from simple interest, where interest is only calculated on the principal amount. This compounding effect can significantly increase the total interest earned, particularly over longer periods of time or with larger sums of money.