For example, if you start out with $100 and you compound annually at 10 percent, you'll have $110 by the end of the year. The second year you add $100 to the account and still earn 10 percent, but you earn it on $210, giving you $231 at the end of the year -- doubling the interest you earned in the first year. It doesn't seem like much at first, but over the long haul all that interest adds up.

Interest can be compounded annually, monthly or even daily, meaning you earn interest on whatever amount you have at the end of that period. Daily compounding gives you more money than annual compounding because your principal -- the amount that earns you interest -- increases every day rather than only once a year. The more frequently your interest is compounded, the more it will grow.

Compounding has more power the earlier you start investing. The following example will show you how.

The Power of Compounding

Say you invest $2,000 a year for 10 years from the time you're 22 until you're 32. Then you stop investing and let the money compound at 10 percent for 28 years until you're 59 1/2, which, depending on the type of account, may be the first time you can remove it without penalty. You'll have $505,629 after contributing a total of $20,000 and letting it compound.