Compound interest is one of the most powerful concepts in personal finance. It lets your savings grow faster because you earn interest on your interest.
This guide explains how compound interest works, with UK examples you can recreate yourself.
What is compound interest?
Compound interest means you earn interest on two things:
- Your original deposit (the principal)
- All previous interest you’ve earned
This creates a snowball effect. Each period, your interest gets added to your balance. Next period, you earn interest on that larger amount.
Here’s a simple example with £1,000 at 5% annual interest:
- Year 1: £1,000 + £50 interest = £1,050
- Year 2: £1,050 + £52.50 interest = £1,102.50
- Year 3: £1,102.50 + £55.13 interest = £1,157.63
Notice the interest grows each year, even though the rate stays the same.
Real example: £200 monthly at 5% return
Here’s what happens when you save £200 per month for 10 years:
| Detail | Amount |
|---|---|
| Monthly contribution | £200 |
| Annual return | 5% |
| Time period | 10 years |
| Total invested | £24,000 |
| Final value | £31,200 |
| Growth from interest | £7,200 |
Compound interest adds £7,200 to your savings—30% more than you put in.
Model your own scenario to see how different monthly amounts or time periods affect your results.
Compound vs simple interest
The difference becomes dramatic over time.
If you invested £10,000 for 20 years at 5% annual interest:
| Type | How it works | Final value |
|---|---|---|
| Simple interest | Only on original deposit | £20,000 |
| Compound interest | Interest on interest | £26,533 |
That’s £6,533 extra from compounding alone.
The longer you save, the more powerful this effect becomes. This is why starting early matters so much.
Three ways to boost savings growth
1. Start as early as possible
Time is your biggest advantage.
Small amounts saved early outperform larger amounts saved later:
- £100/month from age 25 to 65 (40 years) at 5% = £152,602
- £200/month from age 45 to 65 (20 years) at 5% = £82,128
Starting 20 years earlier with half the monthly amount produces nearly double the result.
2. Increase contributions when you can
Even small increases compound significantly.
Going from £200/month to £250/month might not feel dramatic, but over 10 years at 5%, that extra £50/month adds £7,800 to your total.
3. Shop around for better rates
A 2% difference in interest rate compounds into thousands over time.
Using our earlier example of £200/month for 10 years:
- At 3% = £27,942
- At 5% = £31,200
That’s £3,258 extra just from choosing a better rate.
Compare savings accounts regularly, especially for long-term goals.
Put it into practice
Compound interest rewards consistency and patience. The earlier you start and the longer you stay invested, the more dramatic the results.
Whether you’re saving for a house deposit, retirement, or financial security:
- Calculate your compound interest with monthly contributions
- See how different rates and time periods affect growth
- Compare scenarios side-by-side
For more UK finance guides, explore our guides.
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Put This Into Practice
Use our free calculators to model your own scenarios