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Compounding vs. Discounting — What's the Difference?

By Tayyaba Rehman — Updated on September 20, 2023
Compounding is the process of increasing an investment's value by reinvesting the earned interest, while discounting determines the present value of future cash flows. Both are fundamental financial concepts.
Compounding vs. Discounting — What's the Difference?

Difference Between Compounding and Discounting


Key Differences

Compounding and Discounting are crucial pillars in the world of finance, each with its distinct role. Compounding is about growth; it refers to the mechanism where interest or returns on an investment generate their own interest in subsequent periods. Think of it as interest on interest. Over time, the process of compounding can lead to exponential growth in investments.
Discounting, contrastingly, is the reverse process. It's about determining today's value of a sum of money to be received in the future. By discounting future cash flows, one can assess how much they are worth in today's terms, which aids in making investment decisions. Essentially, it recognizes that a dollar today is worth more than a dollar tomorrow due to factors like inflation and opportunity costs.
While Compounding builds future wealth, Discounting translates future money to present value. When you hear about the power of compound interest, it's the magic of Compounding at work. On the other hand, when businesses evaluate projects or investments, they use Discounting to calculate the present value of expected future returns.

Comparison Chart




Amplify growth over time
Determine today's value of future cash flows


Interest on interest
Present value of future sums

Use in Finance

Calculate future value of investments
Evaluate present worth of future returns


Positive (increases value)
Negative (reduces value to current terms)

Compare with Definitions


Exponential growth due to reinvestment of interest.
The magic of Compounding means small savings now can lead to substantial wealth later.


A method to account for the time value of money.
Through Discounting, we realized the contract's true value was less than anticipated.


The growth process where interest earns its own interest.
Sarah's savings account benefits from the power of Compounding annually.


Reducing the future value of money to today's terms.
Discounting helps in understanding the worth of tomorrow's dollar today.


Reinvestment of earnings to generate additional earnings over time.
The quarterly Compounding in the bond helped grow the initial investment.


Present value estimation of future amounts.
The Discounting formula gave us a realistic view of our investment's worth.


Increasing the value of an investment by reinvesting earnings.
With continuous Compounding, even a modest rate can lead to significant growth.


Calculating what future cash flows are worth currently.
Before investing, it's crucial to understand the Discounting rate and its implications.


In the field of pharmacy, compounding (performed in compounding pharmacies) is preparation of a custom formulation of a medication to fit a unique need of a patient which cannot be met with commercially available products. This may be done for medical reasons, such as to be administered by a different route (ex: tablet to liquid), to avoid a non-active ingredient that the patient is allergic to, or to provide an exact dose that isn't commercially available.


The process of determining the present value of future money.
The company is Discounting the future revenues to evaluate the project.


To combine so as to form a whole; mix
Tin was often compounded with lead to make pewter.


Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time, in exchange for a charge or fee. Essentially, the party that owes money in the present purchases the right to delay the payment until some future date.


To produce or create by combining two or more ingredients or parts; compose or make up
Pharmacists compounding prescriptions.


Present participle of discount


To settle (a debt, for example) by agreeing on an amount less than the claim; adjust.


To compute (interest) on the principal and accrued interest.


To add to or intensify so as to make worse
"The university authorities ... compounded their crime in dismissing [the professor] by denying that their action ... reflected any abridgment of academic freedom" (John Kenneth Galbraith).


To make worse by being an additional or intensifying factor
High winds compounded the difficulties of the firefighters.


To combine in or form a compound.


To come to terms; agree.


Consisting of two or more substances, ingredients, elements, or parts.


(Botany) Composed of more than one part
A compound pistil.


A combination of two or more elements or parts.


(Linguistics) A word that consists either of two or more elements that are independent words, such as loudspeaker, self-portrait, or high school, or of specially modified combining forms of words, such as Greek philosophia, from philo-, "loving," and sophia, "wisdom."


(Chemistry) A pure, macroscopically homogeneous substance consisting of atoms or ions of two or more different elements in definite proportions that cannot be separated by physical means. A compound usually has properties unlike those of its constituent elements.


Present participle of compound


An accumulation of compound interest.
The number of compoundings per year


The act of mixing or combining substances to make a compound, such as a medicine


The act of combining things.


The act of combining things to form a new whole


The accumulation of interest on principal and previously accrued interest.
Due to Compounding, James's investment doubled in ten years.

Common Curiosities

Why is discounting important for businesses?

Discounting helps businesses evaluate the present value of future cash flows, aiding in investment decisions and project evaluations.

Can compounding happen daily?

Yes, Compounding can occur daily, monthly, quarterly, or annually. Daily compounding leads to higher returns compared to less frequent compounding.

Is compounding always beneficial for investors?

Yes, Compounding benefits investors as it leads to interest earning its own interest, accelerating growth over time.

What's the significance of a discount rate in discounting?

In Discounting, the discount rate represents the time value of money and factors like risk and inflation, determining the present value of future cash flows.

Does compounding work the same for all investments?

While the principle of Compounding is consistent, the frequency and rate can vary across investments, affecting overall returns.

What factors influence the discount rate?

The discount rate in Discounting is influenced by factors like inflation, interest rates, and risk associated with future cash flows.

Does discounting always reduce the value of future money?

Yes, Discounting always reduces future values to present terms, reflecting the time value of money.

Is a higher discount rate better in discounting?

A higher discount rate in Discounting reduces the present value more, which might be less favorable for assessing future revenues or returns.

Can negative compounding occur?

While not termed "negative Compounding," decreasing returns due to losses can compound, leading to accelerated decreases in investment value.

How do I choose a compounding frequency?

When choosing a Compounding frequency, consider factors like the nature of the investment, expected returns, and financial goals.

How does inflation relate to discounting?

Inflation erodes the purchasing power of future money. Discounting accounts for this, reducing future values to present-day terms.

Is discounting only about future money?

Primarily, yes. Discounting is about translating future cash flows to their present value, accounting for the time value of money.

Why is compounding called the "eighth wonder of the world"?

Compounding can lead to exponential growth over time, turning small investments into substantial sums, making it a powerful financial tool.

Can compounding and discounting be used together?

Yes, both can be used in financial planning. For instance, Compounding to project future wealth and Discounting to assess the present value of future expenses.

How do banks use compounding?

Banks use Compounding for savings and deposit accounts, where interest earned is reinvested, growing the principal amount.

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Author Spotlight

Written by
Tayyaba Rehman
Tayyaba Rehman is a distinguished writer, currently serving as a primary contributor to As a researcher in semantics and etymology, Tayyaba's passion for the complexity of languages and their distinctions has found a perfect home on the platform. Tayyaba delves into the intricacies of language, distinguishing between commonly confused words and phrases, thereby providing clarity for readers worldwide.

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