What is the significance of "compound interest" in finance?

The significance of compound interest in finance lies in its ability to enable investments to grow at a faster rate because interest is earned on both the principal amount and any previously accumulated interest. This concept creates a snowball effect, where the investment potentially increases in value more rapidly as time progresses. For instance, if you invest money and earn interest, that interest is added to your initial investment, and in subsequent periods, interest is calculated on the new, larger total. Over time, this can lead to substantial growth in investments, particularly when the investment period is long, demonstrating the power of time and compounding in wealth accumulation.

This characteristic makes compound interest a fundamental principle in finance, especially for long-term savings and investments, such as retirement accounts or education funds. It distinguishes itself from simple interest, which is only calculated on the original principal, thereby highlighting the advantages of compounding over time in building wealth.