Simple against compound
Simple interest is calculated only on the original principal. Compound interest is calculated on the principal plus all previously accumulated interest, so each period earns on a larger base than the last.
Over short periods the difference is modest. Over long ones it becomes the dominant factor, and this is the single most important idea in personal finance. At eight percent over ten years, compounding outperforms simple interest by roughly a fifth of the principal. Over thirty years the gap is larger than the principal itself.
Compounding frequency
How often interest is added matters, though less than people expect. Moving from annual to monthly compounding at eight percent raises the effective annual rate from 8 percent to about 8.30 percent. Moving from monthly to daily adds only a further 0.02 percentage points.
The returns diminish quickly because there is a mathematical limit — continuous compounding, which at eight percent yields an effective 8.33 percent. Frequency is worth understanding but is rarely the deciding factor between products.
Nominal and effective rates
An advertised rate is usually nominal, meaning it ignores compounding within the year. The effective annual rate accounts for it and is the figure that permits genuine comparison between products with different compounding schedules. When comparing offers, compare effective rates rather than headline ones.
Regular contributions
The contribution field models adding a fixed amount each month, which is how most people actually build savings. The effect is substantial: modest regular contributions over a long period frequently outgrow a much larger single deposit, because each contribution begins compounding from the moment it is made.
This is also why starting early matters more than contributing heavily. A saver who invests for ten years and then stops often finishes ahead of one who starts ten years later and continues for thirty, purely because the early money has more time to compound.
What this does not account for
Two things materially affect real outcomes and are excluded here. Inflation erodes purchasing power, so a nominal return of eight percent with inflation at five percent is a real return of roughly three percent. And tax on interest or gains reduces the compounding base each time it is levied, which is why tax-sheltered accounts compound noticeably faster.
The calculation also assumes a constant rate, which is realistic for a fixed deposit but not for market-linked investments where returns vary and sequence matters.
Not financial advice
This performs arithmetic on the figures you enter. It is not financial advice and does not account for fees, taxes, inflation or investment risk. Consult a qualified adviser before making decisions about your money.
Frequently Asked Questions
What is the difference between simple and compound interest?
Simple interest is calculated only on the original principal. Compound interest is calculated on the principal plus accumulated interest, so growth accelerates over time.
Does daily compounding beat monthly?
Slightly, but the difference is very small. At eight percent, monthly compounding gives an effective 8.30 percent and daily gives 8.33 percent.
What is the effective annual rate?
The rate that accounts for compounding within the year. It is the figure to compare when assessing products with different compounding schedules.
Why do regular contributions matter so much?
Each contribution starts compounding from the moment it is made, so consistent monthly amounts over a long period often outgrow a larger one-off deposit.
Does this account for inflation and tax?
No. Both materially reduce real returns. A nominal eight percent with five percent inflation is roughly three percent in real terms.