Question 1

What is compound interest?

Accepted Answer

Compound interest is interest calculated on both the original principal and the accumulated interest from previous periods. Unlike simple interest (which only applies to the principal), compound interest grows exponentially over time. Einstein allegedly called it the 'eighth wonder of the world' — and the math bears that out.

Question 2

How often should interest compound?

Accepted Answer

The more frequently interest compounds, the faster your money grows. Daily compounding is slightly better than monthly, which is better than annually. For most long-term investments like index funds or 401(k) accounts, compounding is effectively continuous. The difference between monthly and daily compounding is small over short periods but meaningful over decades.

Question 3

What is a realistic annual return for investments?

Accepted Answer

For a diversified stock market index fund (like an S&P 500 index fund), the historical average annual real return (after inflation) is approximately 7%. Nominal returns (before inflation) average around 10%. Conservative planning uses 5–6%, moderate uses 7%, and aggressive (all stocks) uses 8–9%.

Question 4

What is the Rule of 72?

Accepted Answer

The Rule of 72 is a simple formula to estimate how long it takes for an investment to double. Divide 72 by the annual return rate. At 7% returns, your money doubles roughly every 72 ÷ 7 = 10.3 years. At 10%, it doubles every 7.2 years. At 6%, every 12 years.

Question 5

How does adding monthly contributions affect compound growth?

Accepted Answer

Regular contributions dramatically accelerate compound growth, especially early on. A $10,000 lump sum at 7% grows to $76,000 in 30 years. The same $10,000 plus $200/month grows to $283,000 — nearly 4 times as much. The contributions themselves only add $72,000, but compounding turns that into an extra $200,000.

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