What is compound interest? It is interest earned on both your original investment amount (principal) and its accumulated interest. Each time the amount is compounded the previous interest earned is added to the principal. It has the effect of increasing your principal without investing more money.
Here's an example of how it works:
You invest $10,000 in a 2-year CD that returns 5% annually. After one year you'd receive 5%, or $500, interest on your principal of $10,000, giving you $10,500 at the end of year one. Without investing any more money, you'd see that $10,500 increase another 5%, or $525, to $11,025 at the end of year two. No additional investments, and yet thanks to time and interest, your original investment has grown more than $1000. That's the power of compounding interest.
To really demonstrate the power of compounding, take a look at what can happen to your money over a longer period of time. Let's take $10,000 again. Put it in an investment that returns 10% annually, and see what happens as time passes:
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10 years 10% $25,937
20 years 10% $67,275
30 years 10% $174,494