Why is compound interest better than simple interest?

Answer 1

Compound interest is better than simple (or "nominal") interest because compound interest allows you to add your accumulated interest back to your total every given term (i.e. each day, each week, each month, quarterly, annually, etc.), thus increasing the amount of money you are earning interest on.

Example:
Say you deposit 100 dollars for 2 years at 10% per year in 2 banks, one which does not compound your interest (Bank A), and one that compounds annually (Bank B).

Bank A:
After 1 year: 100 x 1.10 (1.10 = your amount + 10%) = 110
After 2 years: 100 x 1.20 (1.20 = your amount +10% x 2) = 120

Bank B:
After 1 year: 100 x 1.10 = 110
but then instead of using 100 again, you add the additional 10 back into your total and collect interest on 110 dollars in year two.
So:
After 2 years: 110 x 1.10 (1.10 = your amount + 10%) = 121