What is compounded interest?

Compounded interest refers to the process where interest is calculated on both the initial principal and the accumulated interest from previous periods. This means that over time, you earn interest not just on your original investment, but also on the interest that has been added to that investment. This compounding effect leads to exponential growth of the investment over time, as the interest begins to generate its own interest in subsequent periods.

For instance, if you invest $100 at an annual interest rate of 5%, at the end of the first year, you'll have $105. In the second year, you'll earn interest on the $105, which results in a total of $110.25, rather than just earning interest on the original $100. This concept is fundamental in finance and demonstrates the power of reinvesting returns to increase wealth over time.