Define compound interest and explain why starting early matters.

• A. Interest earned on both principal and previously earned interest.
• B. Interest is earned only on the principal amount.
• C. Interest is charged on the outstanding balance only.
• D. Interest is never earned, only charged.

Answer: (A)

Compound interest means you earn interest on both the original principal and on the interest that has already been added to the account. Each period, the balance grows based on the entire amount, so the money compounds over time. Starting early matters because more years mean more compounding cycles, allowing growth to accelerate and the final amount to be much larger than if you wait.

A simple way to see it is the future value formula: principal × (1 + rate)^(years). For example, $1,000 at 6% for 10 years becomes about $1,790; for 20 years it grows to about $3,208. The extra years give interest a chance to compound on itself, producing much bigger gains.

The other descriptions describe different concepts: earning only on the principal is simple interest, not compound interest; interest charged on an outstanding balance relates to loans rather than earnings; and never earning interest contradicts the idea of earning interest at all.