Question 1

What is compound interest?

Accepted Answer

Compound interest means you earn interest on your interest, not just on your original principal. For example, £1,000 at 5% earns £50 in year 1, giving £1,050. In year 2 you earn 5% on £1,050 = £52.50, and so on. Over time this snowball effect dramatically accelerates growth, especially with regular contributions. This is why starting early has such a disproportionate effect on long-term savings.

Question 2

How often does interest compound in this calculator?

Accepted Answer

This calculator compounds interest monthly, which is typical for savings accounts, ISAs, and investment platforms. Annual compounding gives a slightly lower result; daily compounding gives slightly higher. The difference between monthly and daily compounding is small at typical savings rates.

Question 3

What interest rate should I use?

Accepted Answer

For cash savings accounts, use the current AER (Annual Equivalent Rate) quoted by your bank, typically 4-5% in the current environment. For a Stocks and Shares ISA or global equity fund, historical returns have averaged around 7-8% per year before inflation over the long run, but past performance is not guaranteed. For inflation-adjusted projections, subtract the expected inflation rate (typically 2-3%) from your nominal rate.

Question 4

How does this compare to a simple interest calculation?

Accepted Answer

Simple interest calculates interest only on the original principal every period. Compound interest reinvests the interest, so you earn more in later years. On £10,000 at 5% for 20 years, simple interest gives £20,000; compound interest gives approximately £26,533. That is a difference of over £6,500, purely from reinvesting the interest.

Question 5

How can I maximise the effect of compound interest?

Accepted Answer

Three levers matter most: (1) Time: starting earlier is the most powerful factor, even if initial contributions are small. (2) Rate: a higher return or lower-fee investment significantly boosts long-term outcomes. (3) Regular contributions: adding to your pot consistently means you are always putting new money to work early. Automating monthly contributions and using a tax-efficient wrapper like an ISA (so you keep all the gains) compounds both wealth and good habits.

Year	Contributions	Interest	Balance
1	£7,400	£322	£7,722
2	£9,800	£783	£10,583
3	£12,200	£1,390	£13,590
4	£14,600	£2,152	£16,752
5	£17,000	£3,075	£20,075

Compound Interest Calculator

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