What does "compounding frequency" refer to in the context of interest?

Compounding frequency refers specifically to the process by which interest is calculated on an account, and then added back to the principal amount to form a new principal for the next interest calculation period. This means that the more frequently interest is compounded, the more interest will be accrued over time, as each compounding period effectively allows interest to earn additional interest.

For example, if interest is compounded annually, it is calculated and added to the principal once a year. However, if it is compounded monthly, interest is calculated and added to the principal twelve times a year. This leads to the exponential growth of an investment or savings account, as each new interest calculation is performed on a growing amount due to prior interest being added.

This process is crucial when evaluating investments or savings options, as it illustrates how the timing of interest calculations can substantially affect the total amount of money earned over time.