Why compounding frequency matters
Compound interest pays interest on interest. The formula is A = P(1 + r/n)^(nt), where n is how many times a year interest is added. The more often it compounds, the more often that interest starts earning on its own.
The effect is real but bounded. Moving from annual to monthly compounding at 8% lifts the effective rate to about 8.30%; moving further to daily gets you only to roughly 8.33%. The jump from annual to monthly matters; the jump from monthly to daily is close to noise.
Nominal rate vs effective rate
The rate a bank advertises is usually nominal — the annual figure before compounding is applied. The effective annual rate shown above is what you actually earn over a year.
When comparing two deposit products, compare effective rates, not headline ones. A 7.9% monthly-compounded account beats an 8.0% annually-compounded one.
Frequently asked questions
What is the difference from simple interest? +
Simple interest is calculated only on the original principal, so it grows in a straight line. Compound interest is calculated on principal plus accumulated interest, so it curves upward — and the gap widens dramatically over long periods.
Does this account for inflation or tax? +
No. The result is a nominal figure. Subtract your expected inflation rate from the interest rate to see growth in real purchasing-power terms.