How compound interest works
With compound interest you earn interest on your interest. Each period the interest is added to the balance, and the next period’s interest is worked out on that larger balance. Over long periods this snowballs: at 7% a year, money roughly doubles every 10 years. Regular deposits add to the effect, because each one starts compounding as soon as it goes in.
Compounding frequency
The quoted annual rate is split across the compounding periods: monthly compounding at 6% adds 0.5% each month, which works out to about 6.17% over a year. More frequent compounding earns a little more, but the difference between monthly and daily is small. Deposits are made every month whatever the compounding frequency.
Why adjust for inflation?
Prices rise over time, so a future amount buys less than the same amount today. The inflation-adjusted value divides the balance by the growth in prices, giving its worth in today’s money. This is an estimate for planning: real returns vary from year to year and taxes and fees are not included.
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