What Is Compound Interest? How Your Money Can Grow Over Time
Compound interest allows your money to grow by earning returns on both your original investment and the returns already generated. Learn why time and patience are key to long-term investing.
What is Compound Interest?
Compound interest is the process where your money earns returns, and those returns then begin earning returns themselves. Over time, this creates a snowball effect that can significantly increase the value of an investment.
For long-term investors, compound interest is one of the most powerful ideas in finance. The three key factors are the amount invested, the rate of return, and the amount of time your money remains invested.
A Simple Compound Interest Example
Imagine you invest £10,000 and achieve an average return of 5% per year, with all returns reinvested.
After the first year, your investment grows to £10,500.
In the second year, you no longer earn interest on just the original £10,000. You earn returns on the new balance of £10,500, meaning your investment grows to approximately £11,030.
Over 10 years, the original £10,000 investment would grow to £16,290. After 20 years, it would be worth £26,530, without adding any extra money.
Why Compound Interest Matters
The biggest advantage of compound interest is time. The longer an investment is allowed to grow, the greater the impact of reinvesting returns.
This is why many long-term investors focus on starting early, staying invested, and allowing their investments to compound over many years.
