Mechanism by which interest accumulates on both the initial capital and previously earned interest, producing exponential growth.
Compounding is the process by which interest is reinvested and in turn earns further interest. The future value of a capital C invested at rate r over n periods is: C × (1 + r)^n. The higher the compounding frequency (monthly, daily, continuous), the greater the final value for the same nominal rate. Continuous compounding gives: C × e^(r×n). The compounding effect is the power of compound interest: over long periods it dramatically amplifies value. In actuarial science, compounding is the inverse of discounting: discounting a future cash flow means dividing by a compounding factor.
1,000 EUR invested at 5% for 20 years: simple interest 2,000 EUR; annual compounding 1,000 × 1.05^20 ≈ 2,653 EUR; monthly compounding ≈ 2,712 EUR.
compounding, intérêts composés, compound interest, capitalisation, intérêts sur intérêts