What is the effect of compound interest on future investment value?

• A. Interest is paid only on the principal
• B. Interest earns on interest over time, increasing growth
• C. Growth is linear, not compounding
• D. Inflation erodes returns

Answer: (B)

Compound interest means you earn interest not only on your original money but also on the interest that has already been added. That “interest on interest” makes future value grow faster over time. If you compare compounding with simple interest, the compounded option yields more money after the same period because each year’s interest is earned on a larger balance.

For example, at 5% annual compounding, a $1,000 investment grows to about $1,157.63 in three years, because each year's interest builds on the previous year’s balance. With simple interest, you’d earn a fixed amount each year on the original $1,000, ending at $1,150 after three years. So the extra growth comes from earning interest on previously earned interest.

The other statements describe different ideas: one is about earning interest only on the principal (simple interest), which is linear rather than compounding; another says growth is linear, which likewise describes simple interest; and inflation eroding returns is about real value over time, not the mechanism by which compound interest increases future value.