The basic idea
Compounding occurs when returns are added to a balance and future returns are calculated on the larger amount. It can work in savings accounts, where interest is paid on past interest, and in investments when earnings remain invested.
Growth is not automatic or guaranteed: savings rates can change, investment values can fall, and the result depends on actual returns, fees, taxes and inflation.
A simple illustration
Suppose $1,000 earns a constant 8% once a year, with no additions, taxes or fees. It would be about $2,159 after 10 years and $10,063 after 30 years. This example assumes a fixed return; real investment returns vary and losses are possible.
Look beyond the headline rate
Annual percentage yield (APY) describes savings interest for a year including compounding. It is not a promise that a variable account will keep the same rate. For investments, examine the return period, costs, tax treatment and risk rather than assuming an average repeats every year.
Questions to ask
How long can I leave the money untouched? Is the rate fixed or variable? What could fees, inflation and taxes do to my result? Could I need the money during a market decline?