Want to boost your savings without adding to them yourself? Or hoping to earn more on what you already save? Compound interest could help to grow your money over time.
Compound interest is calculated not only on the original amount of money deposited, but also any interest earned from previous periods. If you have a savings account this could help to grow your money quicker, as you’re earning interest on your interest.
Compound interest can also apply when borrowing money. You should be aware of this if you do borrow money, as it can increase the amount you owe.
Whilst this article focuses on compound interest, another type of interest to be aware of is simple interest.
Simple interest is calculated on the original deposit sum only. If you deposit £1,000 into an account that pays 5% you will earn £50 in interest every year. At the end of year two you would have £100 in interest.
All examples in this article show earnings through compound interest savings accounts.
The longer you keep your money in a savings account that earns interest without taking any out, the more compound interest you could earn on it. Some savings accounts earn interest yearly, but some earn it more frequently. Getting paid interest more frequently could increase the amount you’re earning.
As you earn interest on the total amount of money in the account, taking money out of it can mean you earn less.
To make the most out of what compound interest can offer, you could leave your money in the account longer term if you can afford to. For example, leaving it for three, five, or ten years.
We know this might sound confusing, so we’ve got some examples to try and help break it down.
Joshua put £1,500 into a savings account that had a 3.5% annual interest rate. He did not plan to add any more to this original amount. But, he wanted to keep it in a savings account longer-term to earn extra money on it so he could eventually gift the money to his son when he got older.
Here’s how his savings grew over time with compound interest:
To reach £2,115.90 in his savings, all Joshua had to do was leave his original £1,500 in his savings account that had a 3.5% interest rate for those 10 years. Because he never took any money out of that account, he earned a total of £615.90 in compound interest.
The figures in this article are just examples. It’s important to remember that interest rates might change over time. You might also need to pay tax on savings interest, depending on how much interest you earn and your annual income.
To find out more, see our Personal Savings Allowance page.
To get started with earning compound interest, you need a savings account to keep the money in. It’s important to find the right account for you and your goals.
There are many ways you can choose to use your savings account to earn compound interest. You could:
It’s best if you can avoid taking money out of your savings account, as this would reduce the amount of interest you could earn.
The earlier you can start saving, and the longer you can leave your money in your account, the more you can reap the rewards of compound interest.
Remember to regularly review your savings account to make sure you’re getting the best interest rate you can.
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