What Is Compound Interest?
Compound interest is interest calculated on both your original principal and the interest you have already earned. Unlike simple interest — which only earns returns on your starting amount — compound interest creates a snowball effect where your money grows faster and faster over time. The longer you leave your money invested, the more dramatic the compounding effect becomes.
In Canada, compound interest is the foundation of wealth-building through registered accounts like the TFSA and RRSP. Every dollar you invest today earns returns, and those returns earn their own returns next year, and so on indefinitely. This is why financial advisors consistently say that starting early matters more than investing large amounts later.
How Compounding Frequency Affects Your Returns
The frequency at which interest compounds — daily, monthly, quarterly, or annually — affects how much you earn, even at the same interest rate. More frequent compounding means you start earning interest on your interest sooner. For example, $10,000 invested at 5% annually compounded monthly grows to $16,470 after 10 years, versus $16,289 compounded annually — a difference of $181 from frequency alone.
Most Canadian savings accounts and GICs compound interest monthly or daily. Stock market investments (ETFs, mutual funds) effectively compound continuously as dividends are reinvested and prices rise. The effective annual rate (EAR) shown in this calculator accounts for compounding frequency and gives you the true annual return.
The Rule of 72 — How Long to Double Your Money
The Rule of 72 is a simple mental math shortcut to estimate how long it takes to double your money. Divide 72 by your annual interest rate, and the result is approximately the number of years to double. At 6%, your money doubles in about 12 years (72 ÷ 6 = 12). At 8%, it doubles in 9 years. This rule works reasonably well for rates between 4% and 12%, and it powerfully illustrates why even small increases in investment returns make a large long-term difference.
Compound Interest in Canadian Registered Accounts
Compound interest is most powerful inside a TFSA or RRSP because your returns are sheltered from tax. In a non-registered (taxable) account, investment gains and dividends are taxed each year, reducing the amount available to compound. Inside a TFSA, every dollar of growth stays in the account and continues compounding tax-free. Inside an RRSP, the same applies — you get tax-deferred compounding, meaning you don't pay tax on the growth until you withdraw in retirement (typically at a lower tax rate).
Frequently Asked Questions
What interest rate should I use for this calculator?
It depends on what you are investing in. For Canadian high-interest savings accounts (EQ Bank, Oaken Financial), current rates are around 3–4%. For GICs, expect 4–5% for 1–5 year terms. For a balanced portfolio of ETFs tracking the stock market, the historical average annual return (before inflation) is approximately 7–9%. Many financial planners use 6–7% as a conservative long-term estimate for a balanced portfolio. The calculator lets you test different rates so you can see the impact of various scenarios.
How does inflation affect compound interest growth?
Inflation erodes the purchasing power of your money over time. If your investments earn 7% annually but inflation is 2.5%, your real (inflation-adjusted) return is approximately 4.5%. This calculator includes an optional inflation field that converts your nominal balance into today's dollars — showing you what your future wealth will actually buy. The Bank of Canada targets 2% inflation annually, and this calculator uses that as a default reference point.
Is compound interest the same as compound annual growth rate (CAGR)?
They are related but not identical. Compound interest is the mechanism — money earning returns on returns. CAGR (Compound Annual Growth Rate) is a measurement tool that smooths out investment returns over multiple years to show a single average annual growth rate. For example, if an investment grew 20% one year and lost 10% the next, the CAGR would be approximately 3.9% — not the arithmetic average of 5%. CAGR is commonly used to compare investment funds and asset performance in Canada.
Does compound interest work the same way on debt?
Yes — and this is critically important for Canadians to understand. Compound interest works against you just as powerfully on debt as it works for you on savings. Credit card debt in Canada typically carries 19.99% interest, compounded daily. A $5,000 credit card balance at 19.99% costs nearly $1,000 per year in interest alone, and that interest gets added to your balance and starts earning interest itself. This is why paying down high-interest debt is mathematically equivalent to earning a guaranteed return at that rate — often better than any investment available.
How much difference does starting 10 years earlier make?
The difference is enormous. Consider two Canadians: one starts investing $300/month at age 25 at 7% annual return, and the other starts at 35. By age 65, the person who started at 25 has approximately $787,000 — while the person who started at 35 has approximately $380,000. The early starter invested only $36,000 more in total ($300 × 12 × 10 years) but ends up with over $400,000 more, purely because of the extra decade of compounding. Starting early is the single most impactful financial decision a young Canadian can make.
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