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🕊️ Financial Planning

What Is Compound Interest and How Does It Work?

Compound interest is interest calculated on both your original principal and the interest that's already accumulated — meaning your money starts earning a return on its own returns, not just on what you originally put in.

The Formula and Why Time Matters Most

Compound interest follows the formula A = P × (1 + r/n)^(n×t), where P is your principal, r is the annual rate, n is how often it compounds per year, and t is time in years. The variable that matters most, by far, is time — someone who starts investing years earlier ends up with significantly more than someone who starts later with the same monthly contributions, even if they invest for fewer total years.

Use the Compound Interest Calculator on this site to see exactly how your own numbers play out over time, including a year-by-year breakdown.

Growing Inside Super vs. Outside Super

In Australia, where you hold an investment changes how much of its compound growth you keep. Inside superannuation, investment earnings are generally taxed at a maximum of 15% (and can be tax-free once you're drawing an account-based pension), compared to your marginal income tax rate on earnings outside super. Outside super, capital gains on assets held for more than 12 months qualify for a 50% Capital Gains Tax discount, and franked dividends come with franking credits that offset some of your tax. Both settings compound your growth — the tax treatment just determines how much of it you keep.

Frequently Asked Questions

What is compound interest?
Interest calculated on both your original principal and the interest that has already accumulated — unlike simple interest, which only applies to the principal. This makes growth accelerate over time.
Does superannuation change how compound interest works?
The maths is the same, but investment earnings inside super are generally taxed at a maximum of 15% (rather than your marginal income tax rate outside super), letting more of your compound growth stay invested — though the trade-off is you generally can't access it before your preservation age.
How much difference does starting early really make?
A large one. Someone who starts investing a decade earlier than someone else, at the same monthly contribution, typically ends up with a meaningfully larger balance — even though they contributed for more years, the extra time for compounding matters more than the extra contributions.
Where can I hold an investment that compounds in Australia?
Common options include superannuation (via salary sacrifice or personal contributions), a term deposit, or a share/ETF portfolio held outside super, each with different tax treatment — see the article on superannuation vs. investing outside super for more detail.

Informational content, not financial, tax, or legal advice. Verify amounts, limits, and current conditions directly with official sources (ATO, ASIC, APRA) before making a decision.

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