What is compound interest?

Compound interest refers to the process where interest is calculated not only on the initial principal amount but also on the interest that has been added to that principal over time. This means that as interest is earned, it is added to the principal balance, and future interest calculations are made on this new total amount. This leads to exponential growth of your investment or savings over time, as you earn interest on both your initial deposit and the accumulated interest.

In contrast, the other choices describe different concepts. Interest calculated only on the initial principal represents simple interest, which does not take into account the accruing interest over time. Interest based solely on savings retained does not accurately capture the definition of compound interest either, as it suggests a limited application without focusing on the growth aspect. A fee charged for investment account management is unrelated to interest calculations; it pertains instead to the costs associated with managing an investment account and does not reflect any earning potential of the investment itself. Thus, compound interest is a concept vital for understanding how savings and investments can grow significantly over time.