compounding

The process by which an investment generates earnings that, in turn, generate their own earnings. This contrasts with simple interest, where only the original principal, or initial amount invested, earns interest. With an interest-bearing asset, the initial interest payment is calculated based on the starting balance. Assuming no withdrawals, all subsequent interest payments are calculated on both the original balance and the accumulated interest (“interest on interest”). When you reinvest dividends and interest, you increase the base amount on which returns are calculated.