The Power of Compound Interest
history_edu What is compound interest?
Compound interest is the interest you earn on both your original money and on the interest you've already earned. Albert Einstein famously called it"the eighth wonder of the world," because it allows your savings to grow exponentially over time.
In the UK, compounding is the engine behind popular savings vehicles like **ISAs (Individual Savings Accounts)** and **Pensions**. By reinvesting returns, you generate a snowball effect where your interest starts earning its own interest.
Frequency Matters
The more often interest compounds (daily vs. annually), the more interest cycles you benefit from. While the difference between monthly and quarterly compounding can be small on a few hundred pounds, it can represent thousands of pounds on a retirement fund over 30 years.
Benefits of Regular Savings
Consistent contributions are often more powerful than a large one-time deposit. This is because each additional deposit starts compounding immediately. In our calculator, even adding £50 a month can drastically shift the final outcome over 20 years.
Example Scenario
Initial: £1,000
Monthly: £100
Rate: 7% (Compounded Monthly)
After 20 years: You have over £52,000 despite only contributing £25,000.
Frequently Asked Questions
What is AER?
In the UK, financial products must show the **AER (Annual Equivalent Rate)**. This standardises compounding frequencies into one yearly figure so you can compare accounts easily.
Does inflation matter?
Yes. While your balance grows, the"purchasing power" of that money may decrease. It's often helpful to assume a slightly lower interest rate to account for inflation in your goals.
What ISAs compound?
Most UK Cash ISAs and Stocks & Shares ISAs compound interest or dividends automatically if you choose"Accumulation" funds or simple interest accounts.