Compound interest is interest or investment growth earned on both the original money and previous interest or growth already added to the balance.
Compound interest in plain English
Compound interest means your money earns interest, and then that interest can also earn interest. In investing, the same idea applies when growth is reinvested and becomes part of the amount that can grow in future.
Simple interest only pays growth on the original amount. Compound interest pays growth on a growing balance. That is why compounding can start slowly but become more powerful over time.
For example, if £1,000 earns 5% interest, the first year’s interest is £50. If that £50 stays in the account, the next year’s interest can be calculated on £1,050 rather than only the original £1,000.
Compounding is especially useful for long-term saving and investing. The more time money has to stay invested or saved, the more chances previous growth has to create future growth.
Compound interest is not magic and it is not always guaranteed. Cash interest can be fixed or variable. Investment returns can rise and fall. But the basic principle is the same: leaving growth inside the account can help the balance build faster over time.
Compound interest formula
The basic formula for a lump sum is:
future_value = present_value × (1 + rate) ^ years
Where:
present_value = starting amount
rate = annual interest or return rate
years = number of years
Regular monthly contributions make the calculation more detailed because each payment has a different amount of time to grow. That is where a compound interest calculator is more useful than a simple formula.
Calculate compound interest
Use the calculator to test a starting balance, monthly contribution, expected rate and timeframe. It can help show how much of the final value comes from your contributions and how much comes from growth.
Compound Interest Calculator
Project long-term savings or investment growth with monthly contributions.
Example of compound interest
The longer money compounds, the bigger the effect can become. This example assumes a £1,000 starting balance, £100 monthly contribution and 5% annual growth.
| Timeframe | Amount contributed | Estimated final value | Estimated growth |
|---|---|---|---|
| 10 years | £13,000 | About £16,900 | About £3,900 |
| 20 years | £25,000 | About £43,000 | About £18,000 |
| 30 years | £37,000 | About £85,000 | About £48,000 |
The growth becomes much larger in later years because earlier growth has had more time to compound.
What affects compound interest?
- Time: longer timeframes give growth more years to build on itself.
- Rate: a higher interest or return rate increases the compounding effect.
- Contributions: regular payments add more money for future growth.
- Reinvestment: leaving interest, dividends or returns in the account strengthens compounding.
- Fees and tax: charges and tax can reduce the amount left to compound.
- Inflation: rising prices can reduce the real value of future money.
Planning note: investment growth is not guaranteed. Use realistic assumptions and test lower-return scenarios too.
Compound interest, ISAs and pensions
ISAs and pensions can help compounding because they shelter growth from some taxes. In an ISA, eligible interest, dividends and gains are normally tax-free. In a pension, growth is generally sheltered while the money stays inside the pension.
The best wrapper depends on access and purpose. A Cash ISA may suit short-term savings, a Stocks and Shares ISA may suit flexible long-term investing, and a pension may suit retirement money that does not need to be accessed soon.
Common compound interest mistakes
- Waiting too long to start: time is one of the strongest parts of compounding.
- Withdrawing growth early: removing interest or returns weakens future growth.
- Using unrealistic rates: high assumptions can make projections look too optimistic.
- Ignoring fees: small fees can have a large effect over many years.
- Ignoring inflation: nominal growth may not mean higher real spending power.
- Stopping contributions too often: regular contributions help build the base that compounds.