Simple interest is calculated only on the initial principal, while compound interest is calculated on both the initial principal and the accumulated interest from previous periods. This means that with compound interest, your investment grows faster as you earn "interest on interest."

The more frequent the compounding, the higher your returns will be. For example, monthly compounding will yield more than annual compounding for the same principal, interest rate, and time period. This is because interest is calculated and added to your principal more frequently, allowing subsequent interest calculations to be based on a higher amount.

Both approaches have advantages. A lump sum investment allows the entire amount to benefit from compounding immediately. However, regular contributions can help average your purchase price over time (dollar-cost averaging) and may be more practical for most investors. Our calculator allows you to see the impact of both strategies or a combination of the two.

Taxes can significantly impact the power of compounding. In taxable accounts, you may need to pay taxes on interest or dividends annually, reducing the amount that gets compounded. Tax-advantaged accounts like retirement plans allow your investments to grow without annual taxation, maximizing the compound effect. This calculator shows pre-tax returns, so consider consulting a tax professional for personalized advice.

Compound interest is only guaranteed in certain fixed-income investments like certificates of deposit or some government bonds. Market-based investments like stocks or mutual funds can experience compound growth but are subject to market fluctuations. The rate of return in these investments is not guaranteed and may vary significantly from year to year, affecting the compounding effect.