Compound interest is interest calculated on both the principal and the accumulated interest. It is interest on interest. A $1,000 deposit at 5 percent earns $50 in the first year. In the second year, it earns 5 percent on $1,050, which is $52.50. The extra $2.50 comes from compounding. Over decades, that small difference becomes enormous.

The math is powerful. At 7 percent annual return, money doubles roughly every ten years. A $10,000 investment becomes $20,000 in a decade, $40,000 in two, and $80,000 in three. Starting early matters more than investing large amounts. A 25-year-old who invests $200 a month until 65 ends up with far more than a 40-year-old who invests $500 a month. Time does the heavy lifting.

Compounding works both ways. Debt compounds too. Credit card balances at 20 percent interest double in under four years if unpaid. Student loans, payday loans, and mortgages all compound. The same force that builds wealth can destroy it. Understanding compounding is one of the most valuable financial skills. It is also one of the least taught. The formula is simple. The patience is not.

Key factors

• Principal amount
• Interest rate
• Compounding frequency
• Time horizon
• Regular contributions