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Understanding Compound Interest

Compound interest is the interest calculated on the initial principal amount, which also includes all of the accumulated interest from previous periods. Often described as "interest on interest," it differs from simple interest, where interest is calculated only on the original principal. Compounding allows investments and savings to grow at an accelerating rate over time.

The concept of compound interest has roots in ancient mathematics, but its power became widely recognized and formalized over centuries. Jacob Bernoulli reportedly discovered the constant 'e' (Euler's number) around 1683 while studying compound interest. Benjamin Franklin famously left bequests to Boston and Philadelphia in 1790, designed to grow through compound interest for 200 years, demonstrating his belief in its long-term potential. Albert Einstein is often apocryphally quoted as calling it the "eighth wonder of the world."

Compound interest is a cornerstone of personal finance, particularly for long-term savings and investments like retirement funds, mutual funds, and savings accounts. The frequency of compounding (annually, semi-annually, quarterly, monthly, daily) significantly impacts the growth rate – more frequent compounding leads to faster growth. Understanding how it works is crucial for making informed decisions about saving, investing, and managing debt (as compound interest also applies to loans and credit cards).