Question 1

What is compound interest?

Accepted Answer

Compound interest is interest calculated on both the initial principal and the accumulated interest from previous periods. This creates exponential growth over time, as you earn interest on your interest. For example, $1,000 at 10% annual compound interest becomes $1,100 after year one, then $1,210 after year two (10% of $1,100, not just 10% of $1,000). The formula is A = P(1 + r/n)^(nt).

Question 2

How does compounding frequency affect my returns?

Accepted Answer

More frequent compounding produces slightly higher returns because interest begins earning interest sooner. Daily compounding yields more than monthly, which yields more than quarterly, which yields more than annually. However, the differences become smaller as frequency increases. The jump from annual to monthly compounding is meaningful, but from monthly to daily is relatively small.

Question 3

What is the Rule of 72?

Accepted Answer

The Rule of 72 is a quick mental math shortcut to estimate how long it takes for an investment to double. Divide 72 by the annual interest rate to get the approximate number of years. At 6% interest, your money doubles in about 12 years (72/6). At 8%, it doubles in about 9 years (72/8). At 12%, it doubles in about 6 years (72/12). This is an approximation that works best for rates between 2% and 15%.

Question 4

What is the difference between APR and APY?

Accepted Answer

APR (Annual Percentage Rate) is the stated annual interest rate without accounting for compounding. APY (Annual Percentage Yield) is the effective annual rate that includes the effect of compounding. APY is always equal to or greater than APR. For example, a 6% APR compounded monthly has an APY of approximately 6.168%. When comparing savings accounts or investments, APY gives you the true annual return.

Question 5

How much should I invest monthly to become a millionaire?

Accepted Answer

It depends on your time horizon and expected return. Assuming a 7% average annual return (roughly the historical stock market average after inflation): starting from $0, you would need to invest about $381 per month for 40 years, $820 per month for 30 years, $2,048 per month for 20 years, or $5,776 per month for 10 years to reach $1 million. Starting earlier dramatically reduces the monthly amount needed.

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