Compound interest is often called the eighth wonder of the world. When it works for you — in savings and investments — it silently multiplies your money over time without extra effort. When it works against you — in debt — it does the same thing in reverse, silently multiplying what you owe. Understanding it is one of the most important financial lessons any Canadian can learn.
Simple interest is calculated only on the original amount you deposited or borrowed (the principal). Compound interest is calculated on the principal plus all the interest that has already accumulated. In other words, your interest earns interest.
This creates a snowball effect. The longer money compounds, the faster it grows — because each period the base amount is larger, so the interest earned is larger, which makes next period's base even larger.
Suppose you invest $100 in a TFSA earning 7% per year, compounded annually:
You invested $100 once and never added another dollar. After 30 years, that single $100 became over $76,000. The last 10 years alone added nearly $38,000 — more than the previous 20 years combined. That acceleration is compound interest at work.
A quick mental shortcut: divide 72 by your interest rate to find how many years it takes to double your money.
This works in reverse for debt too. A credit card balance at 20% doubles every 3.6 years if you make no payments.
Compounding rewards time above all else. Consider two Canadians:
Assuming 7% annual growth, at age 65:
Priya invested one-third as much as David, started 10 years earlier, and ended up with more. That is the power of compound interest over time. The 10 extra years of compounding outweighed $60,000 in additional contributions.
Interest can compound at different frequencies: annually, semi-annually, quarterly, monthly, or daily. More frequent compounding means slightly faster growth.
Example: $100 at 6% for 10 years:
The difference between monthly and annual compounding is modest over 10 years — about $286. Over 40 years it becomes more significant. Canadian mortgages are required by law to compound semi-annually. Savings accounts at online banks typically compound daily.
Everything above applies in reverse when you owe money. A $5,000 credit card balance at 19.99% compounding monthly:
Most people do make some payments — but minimum payments on high-rate debt often barely cover the interest, meaning the principal barely shrinks. This is how Canadians end up trapped in credit card debt for years.
Inside a TFSA or RRSP, compound interest and investment returns are sheltered from tax — which means compounding works at full strength. In a non-registered account, you pay tax on interest and dividends each year, which reduces the amount that compounds. This is a key reason to maximize registered accounts before investing in non-registered ones.
Index ETFs (Exchange-Traded Funds) tracking the Canadian or global stock market reinvest dividends automatically. This reinvestment is a form of compounding — your dividends buy more shares, which earn more dividends, which buy more shares.
Canadian mortgages compound semi-annually by law. On a $500,000 mortgage at 5%, the total interest paid over 25 years is approximately $370,000 — nearly as much as you borrowed. Making even small extra payments dramatically reduces total interest because every dollar of principal paid early is a dollar that stops generating compound interest for the remaining amortization period.
Paying an extra $200/month on a $500,000 mortgage at 5% can save over $40,000 in interest and cut 2–3 years off the amortization. Compounding makes paying down mortgage principal early extremely effective.
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