What does Compound Interest mean?

What does Compound Interest mean?

• A. Compound interest means that you earn interest on the money you deposit, called the principal, first.
• B. Compound interest means you earn interest only on the initial deposit
• C. Compound interest means you pay interest on the principal
• D. Compound interest means you never earn interest

Answer: (A)

The main idea is that money grows by earning interest on both the original amount you deposited and on the interest that has already been added to your balance. In other words, after each period you don’t just earn interest on the principal—you also earn interest on the interest from previous periods, so the balance keeps growing faster over time. A simple way to see it: start with $100 at 5% interest. After the first year you’ve earned $5, balance is $105. In the second year, 5% of $105 is $5.25, so you earn more than you did the year before, and the process repeats. This acceleration is what makes compound interest powerful compared to simple interest, which would only pay you on the original $100 each year. The other ideas—earning interest only on the initial deposit, paying interest on the principal, or never earning interest—don’t describe that growth pattern.

The main idea is that money grows by earning interest on both the original amount you deposited and on the interest that has already been added to your balance. In other words, after each period you don’t just earn interest on the principal—you also earn interest on the interest from previous periods, so the balance keeps growing faster over time. A simple way to see it: start with $100 at 5% interest. After the first year you’ve earned $5, balance is $105. In the second year, 5% of $105 is $5.25, so you earn more than you did the year before, and the process repeats. This acceleration is what makes compound interest powerful compared to simple interest, which would only pay you on the original $100 each year. The other ideas—earning interest only on the initial deposit, paying interest on the principal, or never earning interest—don’t describe that growth pattern.