The Beginner's Guide to Compound Interest

What Is Compound Interest?

Compound interest is the process by which interest earned on an investment itself earns interest over time. It is growth on growth — and time is its most powerful variable.

If you invest $1,000 at 7% annual return, after one year you have $1,070. In year two, you earn 7% on $1,070 — an extra $74.90, not just $70. A tiny difference in year two. An enormous difference over 30 years.

The key insight: You are not just earning interest on your original investment. You are earning interest on all accumulated interest as well.

The Power of Time

Starting Amount	Annual Return	Time	Final Value
$10,000	7%	10 years	~$19,672
$10,000	7%	20 years	~$38,697
$10,000	7%	30 years	~$76,123
$10,000	7%	40 years	~$149,745

The gains in each additional decade increase dramatically. This is why starting early matters so much — not because your early contributions are large, but because they have more time to compound.

The Rule of 72

A quick mental math shortcut: divide 72 by your expected annual return to estimate how many years it takes to double your money:

• At 6%: 72 ÷ 6 = 12 years to double
• At 7%: 72 ÷ 7 ≈ 10 years to double
• At 10%: 72 ÷ 10 = 7.2 years to double

The S&P 500 (tracked by Canadian investors via XIU, VCN, or XAW) has returned roughly 10% annually pre-inflation over the long term. The TSX Composite has averaged approximately 7-8% including dividends.

The TFSA: Canada's Compound Interest Gift

The Tax-Free Savings Account is arguably the most powerful wealth-building tool available to Canadians — and compound interest is the reason why.

Inside a TFSA:

• Contributions are after-tax (no upfront tax deduction)
• All investment growth is completely tax-free
• All withdrawals are completely tax-free, at any time
• Withdrawn amounts are re-added to your contribution room the following year

The 2025 TFSA contribution limit is $7,000/year. Lifetime cumulative room since 2009 is $95,000 (for those who were 18 or older in 2009).

If you invest your annual TFSA limit consistently at 7%:

• After 10 years: ~$97,000
• After 20 years: ~$273,000
• After 30 years: ~$661,000

Every dollar of that growth is tax-free. No capital gains tax. No dividend tax. Complete flexibility to withdraw.

The RRSP: Compound Interest With a Tax Subsidy

The Registered Retirement Savings Plan lets you contribute pre-tax dollars:

• Contribution reduces your taxable income in the year contributed
• Growth compounds tax-deferred inside the plan
• Taxed only on withdrawal (in retirement, when marginal rate is typically lower)

Example: A Canadian in the 33% marginal bracket contributes $10,000 to an RRSP. The CRA effectively gives them a $3,300 refund (via reduced tax). That $10,000 then compounds for 25 years — and the only tax is on withdrawal.

The combination: contribute to RRSP, reinvest the tax refund into a TFSA. Both accounts compound simultaneously.

Compound Interest Working Against You

Credit cards in Canada charge 19.99% to 24.99% on most cards. At 20%, debt doubles in approximately 3.6 years (Rule of 72: 72 ÷ 20 = 3.6). This is compounding working powerfully against you.

Carrying a $5,000 credit card balance at 20% while investing elsewhere almost always produces a negative net outcome. Pay off high-rate debt before investing beyond TFSA contributions.

Practical Starting Points for Canadians

1. Open a TFSA with Wealthsimple, Questrade, or your bank — and invest in low-cost ETFs (VEQT, XEQT, VBAL)
2. Contribute regularly — even $100-$200/month creates meaningful compounding over decades
3. Reinvest dividends — most ETF platforms offer DRIP (Dividend Reinvestment Plan). Compounding accelerates when you reinvest distributions rather than spending them
4. Stay invested — interrupting compounding (selling and sitting in cash) is its most common killer

The most important investment decision for a Canadian under 40 is simply to start, and stay started.