In finance, ‘compound’ refers to the process of earning interest on both the initial principal and the accumulated interest from previous periods. This is known as compound interest. Unlike simple interest, where you earn interest solely on the principal amount, compounding allows your investment to grow at an accelerated rate because you earn interest on all previous interest payments as well as the principal amount, creating a snowball effect.
If you invest a sum of money and it earns interest, that interest is added to the original principal amount, and in the next period, you earn interest on this new, larger amount. This process repeats over time, leading to exponential growth of your investment. Compounding can be applied to various financial instruments, including savings accounts, bonds, and dividends or capital gains from stocks, making it a fundamental concept in personal finance and investment strategies. The power of compounding is maximised over time, making it especially beneficial for long-term investments.