Final answer:
Compound interest is the phenomenon of earning interest on both the principal and the accrued interest, which allows the investment to grow at an increasing rate over time.
Step-by-step explanation:
The phenomenon of earning interest on both the principal and the amount of accumulated interest is known as compound interest. Unlike simple interest, which is an interest rate calculation only on the principal amount, compound interest allows an individual to earn interest on the initial investment (the principal) as well as on the interest that has been added to the principal.
This means that the amount of interest earned grows over time because the interest that gets added to the principal also earns interest in subsequent periods.
For example, let's say you invest $100 at an interest rate of 5% per year compounded annually. After the first year, you would earn $5 in interest, making your total $105. In the second year, you earn 5% of $105, which is $5.25, bringing the total to $110.25, and so on. This is different from simple interest, where if you were to earn 5% per year on $100, you would only get $5 every year, regardless of the total amount in the account.