How compound interest works (and how often it compounds)

Compound interest means earning interest on your starting balance and on earlier interest. How often that happens depends on the product: an Australian savings account may calculate interest daily and credit it monthly, while shares do not have a fixed compounding schedule at all.

The quick answer is that calculation frequency, payment frequency and compounding frequency are not always the same thing. Read the product terms before comparing rates.

How often does interest compound?

There is no universal schedule. These are useful starting points, not substitutes for the terms of a particular account, loan or investment.

Savings accounts: calculated daily, often paid monthly

Many Australian savings accounts calculate each day's interest from that day's closing balance, add those daily amounts together, then credit the total monthly. After the credit reaches the account, it becomes part of the balance that can earn interest in the next period.

“Calculated daily” therefore describes how the bank measures the interest. “Paid monthly” describes when it reaches the account. The account effectively compounds monthly if each monthly credit stays in the account, although the exact method and bonus-rate conditions vary by product.

Mortgages: daily calculation is not necessarily daily compounding

Major Australian lenders commonly calculate home-loan interest each day on the outstanding balance and charge the accumulated amount monthly. That does not automatically mean mortgage interest compounds every day.

With a principal-and-interest loan, scheduled repayments cover the interest and reduce the principal. If interest is not paid and the contract allows it to be added to the loan balance, later interest may be charged on that larger balance. The lender's contract determines when that can happen.

This distinction also explains why an offset balance or an extra repayment can reduce interest: a lower outstanding balance means a lower daily interest calculation. The calculator on this page models savings and investment growth, not mortgage repayments.

Shares: returns compound, but shares do not pay interest

Shares do not compound daily, monthly or annually in the way a bank account does. Their prices can rise or fall, and some companies pay dividends. Compounding is an outcome rather than a payment schedule: gains remain exposed to future gains or losses, and reinvested dividends buy more shares that may generate future returns.

This is why a “7% annual return” in a projection is an assumption used to smooth an uneven path. It is not an interest rate, a promise, or a claim that the market adds 7% once a year.

Bonds: coupons compound only when reinvested

A conventional bond pays coupon interest on specified dates and returns its face value at maturity. The issuer normally does not add each coupon to the bond's principal. Your total return can compound when you reinvest those coupon payments.

Yield-to-maturity calculations usually assume coupons can be reinvested at the same yield. Actual results can differ when reinvestment rates change or a bond is sold before maturity.

How compound interest works

When money in a savings account, super fund or investment earns a return, that return is added to the balance. The next return is worked out from the new, larger balance. Simple interest is different because it is only calculated from the starting amount.

Using the current settings in the chart:

• After 5 years, the balance with regular contributions is $49,623, compared with $14,026 from the starting amount alone.
• After 10 years, those balances are $105,197 and $19,672.

Change the starting amount, contribution or return and these amounts update with the chart. The curve gets steeper because every new period starts with a larger balance.

When does compound interest take off?

There is no magic year or minimum balance. At a steady 5% effective annual return, $10,000 with no extra contributions would grow to about $16,289 after 10 years, $26,533 after 20 years, $43,219 after 30 years and $70,400 after 40 years. The dollar gain in each decade grows because the return is being applied to a larger base.

Time, the rate of return, reinvestment and additional contributions all change when the curve begins to look dramatic. A higher assumed return also brings more risk when it represents an investment rather than a guaranteed deposit rate.

Daily vs monthly vs annual compounding

At the same nominal annual rate, more frequent compounding produces a higher effective annual rate because interest is added to the balance sooner. For $10,000 at a nominal 5% rate over one year:

Daily compounding produces only $1.05 more than monthly compounding in this example. The advertised rate, fees, bonus conditions and access rules can matter far more than the frequency.

If two products instead quote the same effective annual rate, their balance after one year is the same. This is why you need to know whether a quoted rate is nominal or effective before comparing it.

The compound interest formula

With no contributions or fees, the base formula is:

• $P$ is the starting balance.
• $i$ is the effective annual return as a decimal.
• $t$ is the number of years.
• $A$ is the ending balance.

For example, $10,000 growing at an effective rate of 5% for 10 years becomes $16,288.95:

When a nominal annual rate compounds several times per year, use:

Here, $r$ is the nominal annual rate and $n$ is the number of compounding periods each year. For monthly compounding, $n = 12$.

Adding regular contributions

If $C$ is added at the end of each period, the calculator uses:

Here, $j$ is the return for each contribution period and $N$ is the total number of periods. The full calculator shows how this formula changes when you turn on fees or inflation.

Is there an average compound interest rate?

There is no single “compound interest rate.” The useful rate depends on what you are modelling.

• A savings account has an advertised deposit rate, which may be variable and may depend on bonus conditions.
• A term deposit fixes a rate and payment schedule for a set term, but rules can differ on whether interest is paid out or added to the deposit.
• A mortgage rate is the cost of borrowing, applied to the outstanding balance.
• A share-market return combines price changes and income and can be negative.

Use the current rate for the specific product you are modelling. The Reserve Bank of Australia's deposit-rate tables can help with market context, but an individual account's disclosure documents are authoritative. A calculator shows what would happen if its assumptions stayed the same; it does not forecast future bank rates or investment returns.

Try the formula yourself

Open the full calculator to see the formula update when you change contribution frequency or turn on fees and inflation.

Current example: $292,465 after 20 years.