To compound means:
- to calculate interest, return or growth on an accumulating total,
- including earlier amounts of interest, return or growth.
Compound interest is calculated as ‘interest on interest’ as well as interest on the original principal amount.
Compound rates of return or growth are similarly calculated based on the rolling up accumulated total amount, rather than just the initial amount.
Example: compound growth calculation
Rate of growth per year (r) = 30%.
Number of years in the total time under review (n) = 2.
Starting amount $100m
Growth for the first year:
= $100m x 0.30
Balance at the end of the first year:
$100m + $30m
Growth for the second year:
= $130m x 0.30
Balance at the end of the second year:
$130m + $39m
Total percentage growth for the two-year period:
169/100 - 1
= 1.69 - 1