Finance · 2026-06-10
Compound interest is interest calculated on both the initial amount (the principal) and any interest that has already been added. In simpler terms: you earn interest on your interest.
This is different from simple interest, where interest is only calculated on the original principal. The difference between the two becomes dramatic over long time periods — and understanding this difference is one of the most important financial concepts you can learn.
Imagine you put £1,000 in a savings account earning 5% per year.
With simple interest:- Year 1: £1,000 + £50 = £1,050
- Year 2: £1,050 + £50 = £1,100
- Year 10: £1,000 + (£50 × 10) = £1,500
You earn the same £50 every year because interest is only calculated on the original £1,000.
With compound interest:- Year 1: £1,000 + £50 = £1,050
- Year 2: £1,050 + £52.50 = £1,102.50
- Year 10: £1,628.89
The difference after 10 years is £128.89. That might not seem life-changing, but the gap accelerates dramatically. After 30 years, simple interest gives you £2,500, while compound interest gives you £4,321.94 — nearly double.
The formula is straightforward:
A = P × (1 + r/n)^(n×t)Where:
- A = final amount
- P = principal (starting amount)
- r = annual interest rate (as a decimal, so 5% = 0.05)
- n = number of times interest compounds per year
- t = number of years
If interest compounds monthly rather than annually, your money grows slightly faster because interest starts earning interest sooner. The difference between annual and monthly compounding on a 5% rate is small — £1,628.89 vs £1,647.01 after 10 years — but it adds up over decades.
The true power of compound interest is not the interest rate — it is time. Starting early matters far more than starting big.
Consider two savers:
- Saver A invests £200 per month from age 25 to 35 (10 years), then stops. Total invested: £24,000.
- Saver B invests £200 per month from age 35 to 65 (30 years). Total invested: £72,000.
Assuming 7% annual returns, Saver A ends up with approximately £338,000 at age 65. Saver B ends up with approximately £228,000. Despite investing three times as much money and for three times as many years, Saver B has less — because Saver A had an extra decade of compounding.
This example illustrates why financial advisors emphasise starting to save as early as possible. The best time to start investing was yesterday. The second best time is today.
Compound interest works the same way on debt. Credit card debt, personal loans and mortgages all use compound interest — and when you are the borrower rather than the saver, it works against you.
A credit card balance of £3,000 at 20% APR, making only minimum payments, can take over 20 years to pay off and cost more than £4,000 in interest alone. The interest compounds monthly, so you are paying interest on your interest.
This is why paying off high-interest debt is usually the best financial decision you can make. Eliminating a 20% credit card debt is equivalent to earning a guaranteed 20% return on your money — far better than any savings account.
1. Start saving early — even small amounts benefit enormously from compound growth over time.
2. Reinvest returns — dividends, interest and gains should be reinvested to maximise compounding.
3. Pay off high-interest debt first — compound interest on debt erodes your wealth faster than savings can build it.
4. Use a calculator — our free Compound Interest Calculator lets you model different scenarios with varying rates, time periods and contribution amounts, and the Loan Calculator shows the same maths working against you on the borrowing side.
5. Understand inflation — a 5% return with 3% inflation gives you roughly 2% real growth. Factor inflation into long-term planning.
Compound interest is neither complicated nor mysterious. It is simply maths working in your favour when you save, and against you when you borrow. Understanding this single concept puts you ahead of most people when it comes to financial planning.