What benefit does compounding interest provide to investments?

Compounding interest plays a crucial role in enhancing the returns on investments over time. When you earn interest on your initial investment, that interest is then reinvested to generate additional interest in successive periods. This cycle creates a snowball effect, allowing your investment to grow at an accelerated pace compared to simple interest, which is calculated only on the principal. Higher overall returns result because the growth of the investment becomes exponential rather than linear, leading to significantly more wealth accumulation as time progresses.

This mechanism is fundamental to long-term investing strategies. The longer the investment period, the more pronounced the effects of compounding become. This is why starting to invest early can lead to much greater financial outcomes, as even small amounts can grow substantially when compounded over time.