Compound Interest

Interest on interest: how compounding works

With simple interest, you earn interest only on your original principal. Deposit $10,000 at 5% and you collect $500 every year, forever. With compound interest, each year's $500 is added to the balance, and next year you earn 5% on $10,500, then on $11,025, and so on. The interest itself starts working.

In the early years the difference looks trivial. Over decades it becomes the whole story, because compounding is exponential while simple interest is a straight line.

Look at the shape of the numbers below, not just the totals. Simple interest adds the same $5,000 every decade. Compound interest adds about $6,289 in the first decade, $10,244 in the second and $16,686 in the third. Each decade earns more than the one before, and the curve keeps steepening for as long as you stay invested.

Compounding frequency: annual, monthly, daily

How often interest is added to the balance matters. A quoted rate of 5% is a nominal rate; what you actually earn over a year is the effective annual rate, and it rises with the compounding frequency. At 5% nominal, annual compounding gives exactly 5.00%, monthly compounding gives about 5.12%, and daily compounding gives about 5.13%.

Two lessons follow. First, the gap between monthly and daily compounding is tiny, so don't chase it. Second, two products quoting the same rate can pay different amounts, so when comparing offers, compare effective annual rates, not nominal ones.

The Rule of 72

A handy mental shortcut: divide 72 by the annual rate to estimate how many years it takes money to double. At 6%, doubling takes about 72 / 6 = 12 years. At 8%, about 9 years. At 3%, about 24 years.

It is an approximation that works best for rates between roughly 4% and 12%, but it is accurate enough to make the power of small rate differences visible. Moving from 4% to 6% doesn't improve things by half; it cuts your doubling time from 18 years to 12.

Time is the dominant variable

Rate matters, contributions matter, but time matters most, because every extra year compounds everything that came before it. Consider two people who each invest $300 a month at a 6% annual return until age 65.

Starting at 25, the account grows to roughly $597,000 on $144,000 of contributions. Starting at 35, it grows to roughly $301,000 on $108,000 of contributions. The ten-year head start cost only $36,000 more in contributions but produced nearly $296,000 more at the end. The late starter cannot fix this with a better rate; they would need roughly 9% instead of 6% just to catch up.

The corollary is to leave the money alone. A withdrawal does not just remove dollars today; it removes every future dollar those dollars would have compounded into. Interrupting compounding in year 10 to restart in year 12 costs far more than two years of growth, because the largest gains were scheduled for the end of the curve.

It cuts both ways: debt compounds against you

Compounding has no loyalty. On a credit card, unpaid interest is added to your balance and starts accruing interest of its own, and many Canadian cards compound daily at annual rates around 20% or more (as of July 2026). A card quoting 21% costs about 23.4% effective annually once daily compounding is counted, and the balance grows on autopilot exactly the way an investment would.

This is why paying down high-rate debt is often the best "investment" available: eliminating a 21% compounding cost is a guaranteed, tax-free return no GIC or stock can reliably match. (GIC rates sit far below credit card rates in every market.)