Compound interest is the interest calculated on the initial principal and also on the accumulated interest from previous periods. This means that over time, the amount of interest earned grows because you earn interest on both your original investment and the interest that has already been added. For example, if you invest $1,000 at an annual interest rate of 5%, after one year, you would earn $50 in interest. In the second year, you would earn interest on $1,050, resulting in $52.50 in interest. This process continues, leading to exponential growth of your investment over time.