Compound interest is the interest earned not only on the initial principal but also on the accumulated interest from previous periods. Unlike simple interest, it allows money to grow at a faster rate over time.

The formula is:
A = P(1 + r/n)ⁿᵗ

• P = principal amount

• r = annual interest rate

• n = compounding frequency

• t = time

For example, investing $10,000 at 4% annual interest compounded for 5 years grows to about $12,166.53, showing how compounding maximizes returns.

Compound interest can build wealth in savings and investments but also increase costs on loans if debt is not paid quickly, making it a powerful financial tool with both benefits and risks.