Compound interest explained: why time matters more than amount
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Quick answer: Compound interest is earning returns on your past returns as well as your original money. Over long periods it makes the time you stay invested matter more than the exact amount you start with.
Compound interest is often called the most powerful force in personal finance. It works for you when you save and invest, and against you when you borrow. Understanding it is the single biggest reason to start early.
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Read the full investing & ISAs guide →Quick answer: What is compound interest? →Primary source: www.moneyhelper.org.uk
How compounding builds up
Simple interest pays only on your original sum. Compound interest pays on the original sum plus all the interest already added, so each period starts from a slightly larger base. Over a few years the difference is small; over decades it is enormous.
Reinvesting dividends and interest, rather than spending them, is what turns ordinary returns into compounding. Inside an ISA or pension this happens free of UK tax on the growth.
Start early, stay invested
Because compounding rewards time, someone who invests a modest amount in their twenties can end up with more than someone who invests far more starting in their forties. The early money has decades longer to compound.
The flip side is debt: a credit card at around 24% APR compounds against you, which is why clearing expensive debt usually beats investing until it is gone.
Common questions
What is the rule of 72?
Divide 72 by your annual percentage return to estimate the years it takes for money to double. At 6% a year, money roughly doubles every 12 years.
Does compounding beat inflation?
Only if your return is higher than inflation. That is why cash savings can lose real value over time, while long-term investing aims to grow your money ahead of rising prices.