Simple or compound interest: see the difference

The difference lies in what earns interest: the initial principal alone, or principal increased by previous interest.

Start with a shared example

Consider €1,000 invested for three years at a hypothetical annual rate of 5%. With simple interest, each year earns €50, calculated on the initial €1,000. After three years, interest reaches €150 and the total amount is €1,150. This presentation assumes a constant rate, no tax, no fees and no change in principal during the period.

Reinvest the interest

With annual compounding, principal reaches €1,050 after one year. The second year earns €52.50 because interest is now calculated on €1,050. Principal then reaches €1,102.50 and, after the third year, €1,157.625. Rounded to the cent, that gives €1,157.63. The €7.63 difference from simple interest comes from interest earned on reinvested interest.

Read a rate correctly

Compounding frequency matters. A nominal annual rate split into twelve monthly rates does not give exactly the same result as an identical effective annual rate compounded once. Our compound interest calculator uses annual compounding. The monthly saving tool uses a nominal annual rate divided by twelve and assumes payments at the end of the month. Choose the model that matches your question.

Keep assumptions as assumptions

The example rate is not an announced or guaranteed return. A real investment may involve fees, deductions, risk of loss and variable returns. The projection shows the mathematical effect of the entered data. To understand the effect of time, keep the same principal and rate, then compare five, ten and fifteen years. Examine separately what you paid in and what the model attributes to interest.

Put it into practice

• Simple interest
• Compound interest
• Monthly savings

Educational text prepared with AI assistance. The examples use adjustable assumptions and are not personal advice.