What does the term "compound interest" refer to?

The term "compound interest" refers to interest that is earned on both the principal amount and any previously earned interest. This means that, over time, the interest itself can earn interest, resulting in exponential growth of the investment or savings. For example, if you invest money in an account that compounds interest, the total amount grows as the earned interest is added to your principal, which in turn increases the base amount on which future interest is calculated. This compounding effect can significantly increase the value of an investment over time, depending on the interest rate and the frequency of compounding. Understanding compound interest is crucial for effective financial planning, as it highlights the importance of not just saving but also allowing investments to grow through this process.