Compound interest

With simple interest, you earn a return only on your original sum. With compound interest, each period’s return is added to the balance and itself earns a return in later periods. For a sum growing at a constant rate, the final value equals the starting value multiplied by (1 + rate) raised to the number of periods. The same logic applies to investment returns when income is reinvested, and to costs and debts, which compound against you. A handy approximation is the rule of 72: divide 72 by the annual percentage rate to estimate how many years it takes money to double.

Compounding is why time matters so much in investing. Growth in later years comes mostly from returns on earlier returns, so money invested early has a disproportionate effect, and interrupting compounding by withdrawing early or selling in a panic has a lasting cost. It is also why small annual fees add up to large sums over decades. Real returns are not constant, and inflation compounds too, so it is the return after inflation and costs that determines what your money will eventually buy.