Compound interest
In one sentenceA return calculated each period on the original amount plus the return accumulated in previous periods, so the amount grows at an accelerating pace.
Simply put
With compound interest, the return itself becomes part of the amount that earns in the next period. That is why the gap with simple interest grows the longer the period or the more frequent the compounding.
The more frequent the compounding (monthly instead of yearly), the slightly higher the effective return compared with the advertised rate.
Worked example
An amount of 100,000 SAR is invested for one year at 12% a year compounded monthly, meaning 1% each month (a hypothetical rate for illustration).
Monthly rate12% ÷ 12 = 1%
Growth factor for a year(1.01)^12 = 1.126825
With simple interest, for comparison100,000 × 1.12 = 112,000 SAR
Amount after a year = 100,000 × 1.126825112,682.50 SAR
Formula: Original amount × (1 + rate per period)^number of periods
Don't confuse it with
Simple interestIt stays calculated on the original amount only, so the return does not earn a return.