Interest is calculated as a <u>percentage of the principal</u>. With compound interest, the interest earned is <u>added back into the principle</u> so during the next period you start earning interest on the new, higher amount. Every time the interest compounds, it gets added into the principal and you earn more and more interest.
Example:
10% simple interest on $100:
(.1 * 100) +100 = 10 + 100 = $110
But if you do 10% interest compounding monthly for 3 months you have:
Month 1: (.1 * 100) +100 = 10 + 100 = $110
Month 2: (.1*110) +110 = $121
Month 3: (.1*121) + 121 = $133.10
Even with this simple example you can see how much more money is earned when your interest is compounded and added back into the principal.
