Compound Interest

If you put $1,000 in a savings account that pays 2 percent interest annually, the first year you will get $20 back. But the second year you will get a little more back ($20.40) because you also receive 2 percent interest on the $20 you received in interest the previous year. This is called compound interest, referring to the fact that your interest payments are growing over time, or compounding. Previous interest earned is added to the total amount each cycle, making a bigger base from which the next interest cycle is calculated.