Compound interest is a return investors realize when interest is both earned on the original principal and the prior interest earned. For example, the bank compounds your interest once a year. You are currently earning five percent on your original principal of $1,000. In year one, your interest earned is $50. Your principal has now grown to $1,050. In year two the interest remains at five percent. At the end of year two, the principal now increases by $52.50.