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Compound interest is often described as “magical” because it allows small amounts of money to grow exponentially over time. It’s a crucial financial concept that plays a major role in savings, investments, and even debt management.

Whether you’re planning for retirement, saving for a major purchase, or investing in financial markets, understanding compound interest can help you make informed decisions. This guide will explain what compound interest is, how it works, and how you can leverage it to your advantage.

What Is Compound Interest?

Simply defined, compound interest is the interest you earn on your interest. It comes into play with many interest-bearing financial products, such as savings accounts, certificates of deposit (CDs), and bonds.

Unlike simple interest, which is calculated only on your original money (principal), compound interest accumulates on both the principal and the interest that’s added to your balance over time. This “interest on interest” effect enables investments and savings to grow at a faster rate similar to a snowball rolling downhill, getting bigger and bigger as it goes along.

Compound vs Simple Interest

Simple interest is straightforward: It is calculated based only on the principal amount. For example, if you deposit $10,000 in a savings account at an annual interest rate of 3.50% with simple interest, you earn $350 each year, and after 10 years, you would have $13,500.

Compound interest, on the other hand, takes into account not just the principal but also the accumulated interest. If the same $10,000 earns 3.50% annual interest with monthly compounding, the amount grows to $14,183.45 after 10 years. The difference is due to interest being added to the balance, which then earns more interest over time.

Importance of Compound Interest in Finance

Compound interest plays an important role in finance, as it can significantly impact savings, investments, and debts. It benefits savers and investors by exponentially increasing their funds over time, making it a key principle behind financial growth strategies. On the flip side, it can work against borrowers, as debts can grow significantly if interest compounds frequently.

In finance, the term “compound interest” generally refers to interest calculated on accounts like savings accounts, bonds, and loans. Some checking accounts also earn compound interest.

The term “compound returns,” on the other hand, is broader in scope — it can include interest as well as other types of investment returns, including dividends and capital gains.

How Does Compound Interest Work?

When talking about interest and how it works, you are likely to hear the terms simple interest and compound interest. Comparing the two can be a good way to illuminate what compound interest is.

Understanding Compound Frequency (Daily, Monthly, Annually)

The frequency of compounding determines how often interest is added to the principal. The more frequently interest compounds, the faster the total amount grows. Common compounding periods include:

•   Daily: Interest is calculated and added each day, leading to faster growth.

•   Monthly: Interest is compounded 12 times a year, making it slightly less aggressive than daily compounding.

•   Annually: Interest is compounded once per year, resulting in slower growth compared to more frequent compounding periods.

Recommended: How to Manage Money

Formula for Calculating Compound Interest

If you want to get technical, there’s a compounding interest formula you can use to calculate your total savings including compound interest over time.

A = P(1+r/n)^nt

Where:

A = Final amount (principal + interest)

P = Principal (initial amount)

r = Interest rate (decimal form)

n = Number of times interest is compounded per year

t = Number of years

You could plug numbers into this formula to project your earnings. Or, if you’d rather not get into complicated math, you can use a compound interest calculator to determine how much your savings will grow based on the initial deposit, interest rate, compound frequency, additional contributions, and length of time.

Examples of Compound Interest Calculations

To illustrate how compound interest works, here’s an example using a deposit amount of $5,000 and a healthy 10% interest rate that’s compounded annually. After the first year, the account would earn $500. But starting with the second year, the 10% interest would be calculated based on the new amount of $5,500, not just the original $5,000.

Future Value of $5,000 Deposit Compounded Yearly at 10%

The chart below shows an estimate of how much $5,000 can grow over time using the power of compound interest. These numbers assume that you will earn an interest rate of 10% that compounds annually and that don’t make any additional deposits over the next 10 years.

Benefits of Compound Interest

If you’re looking to grow your savings, compound interest offers some key benefits:

•   Accelerated growth. Compounded interest helps money grow exponentially, thanks to its “snowball effect” of your interest earning interest.

•   Wealth building: Compound returns can make it easier to reach long-term goals like saving for retirement or paying for a child’s future college education.

•   Inflation protection: Earnings from compounding help offset the effects of inflation on your savings over time.

Strategies to Maximize Compound Interest

Compound interest, on its own, can boost savings. Yet, there are ways you can make more out of this financial strategy. Here are some to consider:

•   Making additional contributions: Regularly adding to your principal, either manually or through automated saving, amplifies the benefits of compounding. Consider a person who tucks away $1,000 for 10 years at a 6.00% return (compounded annually). At the end of that period, they will have $1,790.85. If the same person made an additional monthly contribution of $100, at the end of the period they would have $17,607.80.

•   Switching banks: To get the best return on your savings, it pays to shop around and compare annual percentage yields (APYs). The APY takes compounding into account and makes it easier to compare banking products apples to apples. The average savings account offers relatively low APYs — 0.42% APY as of December 16, 2024. A high-yield savings account, however, may pay 3.00% APY or higher.

•   Starting early: “When figuring out how to become financially independent, it can behoove individuals to invest early and often,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi. “Even if it’s only $25 or $50 per month, small amounts can add up. By investing earlier than later, money has more time to grow and for returns to compound.”

Recommended: How to Switch Banks

Common Misconceptions About Compound Interest

Here’s a look at some common myths and misunderstandings about compounding.

•   It only benefits the wealthy: Compound interest benefits anyone who saves, regardless of their initial amount.

•   It works the same for savings and debt: Compound interest is a benefit when you’re saving, but a negative when you’re borrowing. For example, compound interest often applies to interest added to credit card balances, which can make them harder to pay back.

•   Short-term results are noticeable: Significant gains that come from compound interest come over long periods, not immediately.

•   Higher compounding frequency leads to large gains: While more frequent compounding helps, the effect is marginal compared to the impact of time and rate of return.

The Takeaway

Compound interest helps your money work harder. It allows the interest you earn on your original deposit to earn interest of its own, which accelerates growth. This is in contrast to simple interest, which pays interest based on the principal alone. Any accumulated interest is not factored into future interest payments.

If you’re looking to get a good return on your money, it pays to compare APYs, which tell you how much you will earn on your funds in one year, taking the interest rate and compounding periods into account. You’ll also want to keep an eye out for any account fees, which can eat away at your principal and lessen the impact of compound interest.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

FAQ

How much do people typically make in compound interest?

There is no typical amount that people make in compound interest because there are several variables involved: the principal, the interest rate, how long the interest accrues for, and how often it is compounded. To check specific scenarios, you can use an online compound interest calculator.

Is it better to have simple or compound interest?

If you are depositing money and hoping to have it grow over time, earning compound interest vs. simple interest will help it grow faster. However, if you are paying interest on a debt, simple interest will accrue more gradually and therefore be easier to pay off.

Do all banks offer compound interest savings accounts?

Many banks offer savings accounts with compound interest. It can be worthwhile to check to see how often the interest is compounded: daily, monthly, quarterly, or annually. The more frequent the compounding, the faster your money will grow.

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SOBNK-Q125-049

Infrastructure investment is an alternative strategy that focuses on the physical structures and systems that keep societies operational. Examples of public infrastructure include: railways, highways, harbors, cell towers, school, and wastewater treatment facilities.

As a type of alternative investment, infrastructure is not correlated with traditional assets like stocks and bonds. As such it may provide portfolio diversification. Infrastructure investments come with specific risks, however.

Examining how infrastructure investments work and their pros and cons can help you determine if they might be right for you.

Defining Infrastructure Investment

Infrastructure investing refers to investment in the tangible assets that societies rely on to function, from power plants and parking lots to hospitals and schools. It’s an example of an alternative investment, since infrastructure investments are typically not correlated with traditional assets, such as stocks, bonds, and cash, or cash equivalents.

As a strategy, alternative investments offer the potential to generate higher risk-adjusted returns compared with traditional assets, though this typically comes with higher risk. Infrastructure investments are illiquid, and can be subject to interest rate fluctuations, regulatory changes, and risks owing to climate change and extreme weather.

Infrastructure investment funds, infrastructure stocks, and municipal bonds are some of the ways to invest in this alternative asset.

Types of Infrastructure Assets

Infrastructure assets are long-term capital assets that are used to provide public services. They’re most often stationary and typically have a long life or period of usefulness. Examples of infrastructure assets include:

•   Roads, bridges, tunnels

•   Water, sewer, and drainage systems

•   Dams

•   Municipal lighting

•   Communications networks, cell towers

•   Schools

•   Healthcare facilities

•   Prisons

Infrastructure assets are viewed separately from equipment used to construct critical structures. For example, a new road is an example of an infrastructure asset but the asphalt paving machine used to build it is not.

Public vs. Private Infrastructure Projects

Public infrastructure is available for public use and is funded through public means, such as municipal bonds. When you buy a municipal bond you’re agreeing to let the bond issuer, typically a city or local government, use your money to support public works projects for a certain period. In return, the bond issuer pays you interest, and at the end of the term, you can collect your original investment plus the interest.

Private infrastructure projects use capital from private investors to further the construction or improvement of critical structures. An infrastructure investment fund, for example, may concentrate private equity in a specific sector or subsector.

Importance of Infrastructure Investment

Infrastructure investment is important for many reasons, starting with its impact on the economy. Without roads, railways, airlines, and waterways, people and goods can’t get where they need to go. Transportation infrastructure facilitates economic growth and reduces disruptions to the supply chain. Investing in utilities, such as electricity and water is also crucial.

Quality of life and basic needs are also dependent on infrastructure. When infrastructure is not maintained, societies risk losing access to safe, clean drinking water, communications, housing, and health care.

Infrastructure investment also serves as a line of defense against cyberattacks, which can threaten the security of everything from banking systems to the electrical grid. In short, investment in infrastructure makes life as we know it possible.

Recommended: Alt Investment Guide

Infrastructure Investment Sectors and Projects

Infrastructure investments can target a specific sector or type of project. Here’s a quick look at different areas of infrastructure investing.

Transportation Infrastructure

Transportation infrastructure refers to structures and systems that allow goods and people to move from one place to another. Examples of transportation infrastructure projects include the building or maintenance of:

•   Canals that allow cargo ships to pass from one body of water to another

•   Ports which allow cargo ships, cruise ships, and other maritime vehicles to dock for the purpose of loading or unloading people and goods

•   Mass transit systems such as subways and buses that allow people to navigate around a large urban area without a car

•   Roads, streets, and highways designed for different speeds and levels of capacity

In the U.S., the interstate highway system is one of the largest public works infrastructure projects ever undertaken.

Energy Infrastructure

Energy infrastructure includes all of the systems and structures that are necessary for generating or transmitting energy to a population. Here are some examples of energy infrastructure projects.

•   Solar panel systems that provide power for street lamps along a highway

•   Large-scale wind turbine farms that generate electric energy for a local population

•   Battery energy storage systems that connect to the existing electrical grid

The Hoover Dam is an example of an energy infrastructure project. The dam was built through a combination of public and private funds, as the government focused on improving infrastructure to generate jobs amidst the Great Depression.

Telecommunications Infrastructure

Telecommunications infrastructure, or telecom, encompasses the various systems and structures people and businesses use to communicate. Telecom infrastructure includes:

•   Telephone lines

•   Fiber-optic cables

•   Wireless networks

•   Routers

•   Cellular phones

Satellites are also an integral part of telecom infrastructure. Global governments and organizations, including NATO, rely on satellites to keep the lines of communication open.

Financing Infrastructure Investments

There are several ways infrastructure investments are financed. Capital may come from public investments and government programs, private investment, or infrastructure funds.

Public Funding and Government Initiatives

Public funding for infrastructure projects most often takes the form of bonds. Investors get the benefit of regular interest payments while the bond issuer is able to get the capital they need to invest in infrastructure.

Bonds are a form of direct investment in infrastructure; taxes are an indirect method. When you pay taxes at the local, state, or federal level, some of that money goes toward funding infrastructure projects. Governments use tax dollars, along with revenue collected from other sources, to build or improve infrastructure.

Private Investment and Public-Private Partnerships

Private investment provides financing for infrastructure projects through individual and institutional investors. When you invest in this type of fund, you may gain exposure to multiple infrastructure classes or just one — it all depends on the fund’s goals and objectives.

Public-private partnerships (PPPs) are arrangements in which private investors and governments work together to support infrastructure projects. PPPs can be used to address a variety of infrastructure needs, from building parks and recreation centers to constructing new roadways.5

Infrastructure Funds and Asset Management

Infrastructure funds allow investors to gain exposure to companies or industries that engage in infrastructure activities. For example, you might invest in a fund that holds companies in the shipping and ports sector or a fund that’s dedicated to investing in utilities.

Investing in infrastructure through mutual funds or exchange-traded funds (ETFs) allows for diversification. You can hold a collection of investments in a single basket, rather than purchasing shares of individual infrastructure stocks.

Infrastructure asset management refers to strategies for managing infrastructure assets. It encompasses key decision-making processes related to the maintenance of infrastructure systems, including risk management and cost management.

Advantages of Investing in Infrastructure

As discussed earlier, because infrastructure is an alternative asset class it’s not correlated with conventional assets like stocks and bonds. Thus, it can provide some portfolio diversification and may help mitigate volatility in other asset classes.

And because infrastructure is generally comprised of long-term physical assets that typically require a high initial investment, these structures tend to be durable. This contributes to lower ongoing investment expenses, and steady yields from population use (i.e., tolls, utility payments, transportation fees).

In that way, infrastructure can also be a resilient investment in the face of other sources of volatility. For example: what happens in the stock market generally won’t impact bridges and tunnels, or the long-term impacts could potentially trickle down in more predictable ways (material costs, interest rate changes) over time.

Risks and Challenges in Infrastructure Investing

Infrastructure investments are exposed to a variety of risks. As an investor, it’s important to understand what those risks can mean for your portfolio.

The most common risks and challenges include:

•   Interest rate risk: This is the risk of interest rates rising or falling in a way that could impact bond rates, as well as the cost of loans for construction and development of certain projects.

•   Regulatory risk: Because municipal structures depend on local regulations, changes in laws and policies can impact how quickly a project may ramp up, and whether new standards or guidelines will increase costs.

•   Construction risk: Construction risk can be a problem if the builder of a project experiences delays, if there are structural impediments that cause significant delays, or if the builder walks away from the contract before the project is complete.

•   Event risk: Infrastructure projects can face a wide range of potential threats from outside forces or actors, including the possibility of cyberattacks, supply chain attacks, and data breaches. Natural disasters, a changing climate, and geopolitical upheaval can also prove challenging for maintaining infrastructure.

The Takeaway

Infrastructure investing might be of interest to you if you’re looking for a way to expand your investments beyond stocks and bonds and diversify your portfolio. The most important thing to remember about alternative investments like infrastructure is that they may carry a higher degree of risk. It’s wise to weigh those risks against the potential returns or other benefits before wading in.

Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.

FAQ

What are some examples of infrastructure investments?

Examples of infrastructure investments include municipal bonds that are used to build or improve local roads, public-private partnerships that aim to build more green spaces, and energy sector ETFs.

How can individual investors participate in infrastructure investing?

Infrastructure stocks, mutual funds, ETFs, and municipal bonds may offer the easiest points of entry for investors. You could buy individual shares of stock in an infrastructure company, hold a collection of infrastructure investments in a single fund, or earn interest from muni bonds while helping to fund infrastructure projects.

What are the typical returns on infrastructure investments?

Infrastructure investments can generate returns that may be higher or lower than typical market returns, but it’s important to remember that infrastructure typically does not react to market volatility the same way as conventional assets might. Also some infrastructure investments can offer predictable yields versus other assets.

About the author

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.