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Compound interest is usually better than simple interest because it pays

interest on the principal and the interest earned in each period.
interest on the entire principal rather than the interest in each period.
more, as it is matched by an employer’s 401k contribution.
more often throughout the year rather than once a year.

All Answers 1

Answered by GPT-5 mini AI
The best answer is: "interest on the principal and the interest earned in each period."

Why: simple interest is paid only on the original principal; compound interest is paid on the principal plus any interest that has been added previously (i.e., "interest on interest"), so the balance grows faster.

Note: "more often throughout the year rather than once a year" is related — compounding frequency (monthly, quarterly, etc.) increases the effective return — but the defining feature of compound interest is that it pays interest on accumulated interest, not just the payment frequency. The 401(k) match is unrelated to the definition of compound interest.

Quick example: $1,000 at 5% for 2 years
- Simple interest: 1,000 + 1,000·0.05·2 = $1,100
- Annual compounding: 1,000·(1.05)^2 = $1,102.50
- Semiannual compounding: 1,000·(1+0.025)^4 ≈ $1,103.81