How Does Compound Interest Work by Dan Lok

Simple interest is the interest you earn only on your principal investment.

Example: If you invest $1,000 and earn 5% simple interest for five years, you will earn $50 in interest every single year.
Simple interest remains constant over time.

Compound interest is the idea of "interest on interest," which occurs when you reinvest your interest earnings to make more money.

You are earning interest on a perpetually increasing amount because the previous year's interest is added to your principal.
Example: Investing $1,000 in an account that compounds annually at 5%:
- Year 1: $50 interest.
- Year 2: $52.50 interest (5% of $1,050).
- Year 3: $55.13 interest (5% of $1,102.50).
This growth enables you to build wealth without lifting a finger and allows your passive income to grow exponentially.

The video highlights the drastic difference between saving and investing over a long period:

Action	Annual Investment	Rate of Return	Value After 40 Years
Saving (putting $1/day in a safe)	$365	0%	$14,600
Investing (e.g., in an S&P 500 Index Fund)	$365	~10% (historical average)	$177,701

While saving is important, true wealth cannot be achieved without the benefits of compound interest
Compound interest, which requires a long-term outlook, can amplify your wealth trajectory and help you prepare for future financial needs.