In investing, compound interest is the process of earning returns on both an investment and its previously earned returns.
With compounding, earlier earnings remain invested and can generate additional earnings. For example, an account earning interest may grow faster over time when the interest is added to the balance instead of being withdrawn. The effect depends on the starting amount, rate of return, time period, and compounding frequency.
Although the term traditionally refers to interest, the same principle applies to reinvested dividends and other investment returns. Compounding is not a guaranteed way to make money: investments can lose value, and returns on securities vary. Fees, taxes, and inflation can also reduce the amount that actually compounds.
Compound interest is commonly confused with simple interest, which calculates returns only on the original principal. Albert Einstein is often credited with calling compound interest the “eighth wonder of the world,” but that quotation is widely regarded as unverified.