Compound interest is a fascinating concept that has been described as the eighth wonder of the world. This powerful force has the potential to make your money grow exponentially over time, and understanding it can be the key to achieving financial success. In this blog, I will explore what compound interest is, how it works, and why it’s so important to make it a part of your financial strategy.

 

What is Compound Interest?

Compound interest is a financial concept that refers to the interest earned on the principal amount of money, as well as the interest earned on any previously earned interest. Simply put, it’s interest on interest. When you invest your money in a savings account, a fund, or other financial instrument, the interest you earn is added to your principal balance. The next time interest is calculated, it’s done on the higher balance, which means you earn more interest. This process continues, and over time, the interest earned can become a significant portion of your total investment.

 

 

How Does Compound Interest Work?

Compound interest can be calculated using a formula that takes into account the principal amount, interest rate, and time. The formula is A = P(1+r/n)^nt, where A is the total amount of money after a certain number of years, P is the principal amount, r is the annual interest rate, n is the number of times interest is compounded per year, and t is the number of years the money is invested.

For example, if you were to invest £10,000 in a fund with an annual interest rate of 8%, compounded quarterly (four times a year), and leave it there for 10 years, the formula would be:

A = £10,000(1+0.08/4)^(4×10)

A = £21,589.46

As you can see, the interest earned over 10 years is more than double the original investment. If the interest had been simple interest (calculated only on the principal amount), the total amount after 10 years would be £18,000, which is significantly less.

 

 

Why is Compound Interest So Powerful?

Compound interest is powerful because it allows your money to work for you over time. As the interest earned is added to your principal amount, the amount of interest earned increases. This means that over time, your money grows exponentially, and you can earn more interest on your interest.

As Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” By investing early and consistently, you can take advantage of this powerful force and grow your wealth over time.

 

 

Final Thoughts

In conclusion, compound interest is a powerful force that can help you achieve financial success. By understanding how it works and making it a part of your financial strategy, you can watch your money grow exponentially over time. As Warren Buffett once said, “My wealth has come from a combination of living in America, some lucky genes, and compound interest.” So start investing today and let the power of compound interest work for you.  You know it makes sense.*

 

RISK WARNING

*The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based purely on personal opinion and experience.