Simple versus compound interest: when does the difference appear?
The difference depends on whether interest remains invested and earns further interest. A two-year example makes the mechanism visible without relying on a large long-term projection.
Compound interest →Establish what happens to the interest
Simple interest is calculated on the original principal. Compound growth includes previous interest in the later interest-bearing balance. If interest is withdrawn instead of retained, the account balance cannot be projected as though all interest were reinvested. The payment and reinvestment terms therefore matter as much as the headline percentage when choosing a calculation method.
Work through two years
Start with 1,000 at 5% annually and make no additional deposits. Two years of simple interest give 1,000 × 5% × 2 = 100, for a total of 1,100. With annual compounding, the first year ends at 1,050 and the second at 1,050 × 1.05 = 1,102.50. The extra 2.50 is interest on the first year’s 50 of interest. These are original illustrative figures, not a quoted savings product.
Match the tool to the agreement
Use the simple-interest calculator for the first model. In the compound tool, set monthly contributions to zero; entering a 5% effective annual rate for two years gives the same 1,102.50 annual-equivalent result. Taxes, fees, withdrawals and changing rates are excluded from this demonstration. The assumed 5% return is not guaranteed, and market investments do not normally produce a smooth fixed return every year.
Try the calculators
- Compound interest
See how your savings can grow over time.
- Simple interest
Calculate interest without compounding.
- Investment calculator
Project an investment with regular contributions.