What is the effect of compound interest on savings over time?

The effect of compound interest on savings over time is significant, as it accelerates the growth of savings. Compound interest works by calculating interest not just on the initial principal amount but also on the accumulated interest from previous periods. This means that as time passes, the amount of interest earned grows because it compounds, resulting in a higher total savings compared to simple interest, which is calculated only on the principal.

For example, if you invested a sum of money at a compound interest rate, the interest earned in the first year is added to the principal, and in the second year, interest is calculated on the new total. This process continues, leading to exponential growth in your savings, especially over long periods. The value of compound interest is often referred to as "the miracle of compounding," highlighting its ability to enhance savings substantially over time.

In contrast, choices indicating that compound interest decreases savings, has no effect, or only applies to loans fail to recognize the fundamental nature of compound interest and its powerful role in growing wealth through efficient savings strategies.