Compounding

Definition

Compounding is earning interest on interest. More frequent compounding increases the effective annual rate (APY) for a given APR.

Formula

APY = (1 + APR / n)^n - 1

Example

At 10% APR, annual compounding yields 10%. Monthly compounding yields 10.47% APY.

How to use it

• Compounding frequency (daily, monthly, quarterly) changes the effective return.
• APR is the nominal rate; APY reflects compounding effects.
• Small rate differences can compound into large gaps over long horizons.
• Compounding applies to growth rates too (revenue, users, and cash).
• Use the same compounding basis when comparing products.
• Long horizons amplify small compounding differences.
• Align compounding with payment timing when modeling loans or savings.

Common mistakes

• Comparing APR to APY without converting to the same basis.
• Assuming compounding frequency does not matter for short horizons.
• Ignoring fees that reduce effective yield.
• Mixing nominal and effective rates in the same model.
• Using annual rates in monthly models without converting.
• Applying compounding to one line item but not to the related assumptions.

Why this matters

This term matters because cash timing and risk are usually the difference between a plan that works on paper and a plan that survives. Use consistent definitions so decisions are comparable over time.

Practical checklist

• Write a 1-line definition for "Compounding" that your team will use consistently.
• Keep the time window consistent (weekly/monthly/quarterly) when comparing trends.
• Segment results (channel/plan/cohort) before drawing big conclusions from blended averages.
• Use a calculator that references this term (e.g., APR to APY Calculator) to sanity-check assumptions.
• Read the related guide (e.g., APR vs APY: how compounding changes the effective rate) for context and common pitfalls.

Where to use this on MetricKit