Compound Interest Explained So Simply a 12-Year-Old Gets It
You lend money to the bank. The bank pays you interest. Then the bank pays you interest on the interest. Then interest on the interest on the interest. Forever.
You put $1,000 in a savings account earning 5% per year. Year 1: you earn $50 (5% of $1,000). Balance: $1,050. Year 2: you earn $52.50 (5% of $1,050 — not $1,000). Balance: $1,102.50. Year 3: you earn $55.13 (5% of $1,102.50). Balance: $1,157.63. The extra money each year comes from earning interest on your previous interest. That is compounding.
Why It Gets Crazy Over Time
$1,000 at 10% compounded annually: After 10 years: $2,594. After 20 years: $6,727. After 30 years: $17,449. After 40 years: $45,259. After 50 years: $117,391. You added zero dollars after the initial $1,000. Every penny above $1,000 came from compounding. The growth in the last decade ($72,000) exceeds ALL the growth in the first 40 years combined ($44,000). This is why starting early matters more than starting big.
The Dark Side
Compound interest works identically on debt — but against you. A $5,000 credit card balance at 24% APR with minimum payments: you will pay $11,000 total and it takes 9+ years. The credit card company earns more from your interest than you originally spent. The lesson: make compound interest work FOR you (investments) and stop it from working AGAINST you (debt) as fast as possible.