Glossary · Risk & Strategy
Compound interest
Earning returns on both principal and previously earned returns.
Compounding happens when gains themselves start generating more gains. Over long periods, this snowball can matter more than any single year’s return — which is why time in the market is such a common investing theme.
Compounding works against you too: high-interest debt grows the same way. In investing accounts, reinvested dividends and reinvested ETF distributions are common engines of compounding.
Example
Invest $1,000 at 8% annual return. After year one you have about $1,080. Year two earns 8% on $1,080, not just on the original $1,000 — that extra is compounding.