What is compound interest?
Albert Einstein once described compound interest as the 'eighth wonder of the world'. Fortunately, you don’t have to be a genius like him to understand it. Put simply, it’s interest that earns interest. Almost as good as the Pyramids of Giza.
Where have you heard about compound interest?
Savings accounts and cash ISAs are well-known examples of money that earns compound interest. The earlier you start investing in such products, the more time you’ll have for compound interest to take effect and make your savings grow.
What you need to know about compound interest.
Compound interest gives you better returns than simple interest, which is calculated only on the principal sum invested.
For example, if you invest £1,000 for a period of 3 years with a 4% annual interest rate, the simple interest for each year will be £40. But, with compound interest, the interest for year 2 will be £41.60 because you would also earn 4% on the £40 interest you earned in year 1. In Year 3, instead of £40 you'd get £43.26
Although it doesn’t seem that much after only 3 years, if you save your money for a longer period, and keep adding to the pot, you can really see your savings snowball.
Find out more about compound interest.
Read our definition of simple interest to learn how it differs from compound interest.