Compound interest calculator (UK)

What is compound interest?

Compound interest is the interest earned on both the initial amount and any accumulated interest.

This allows your savings to grow faster as the interest is added to the principal amount daily or monthly, increasing the total amount on which future interest is calculated.

How does the compound interest calculator work?

The UK compound interest calculator above uses the compound interest formula to find the principal plus interest.

It uses this same formula to find the principal, rate or time given the other known values.

You can also use this formula to set up a compound interest calculator in Excel or a Google Sheet.

A = P(1 + r/n)nt

In the formula

• A = final amount

• P = initial principal balance

• r = interest rate

• n = number of times interest is applied per time period

• t = number of time periods elapsed

Calculating compound interest vs simple interest

As the name implies, simple interest is calculated simply.

All you have to do is multiply the original (‘principal’) amount by the interest rate, to get the amount of interest paid per year.

You then multiply this figure by the number of years the money is invested (or loaned).

In practice, simple interest is rarely used in the world of investments.

Compound interest is more favourable to investors and works like the below..

The first year of interest is calculated as above: by multiplying the principal amount by the interest rate.

So £100,000 at 4% interest (100,000 x 1.04) will be around £104,000 at the end of the first year.

Now, this amount becomes the principle.

In the second year, you multiply £104,000 by the same interest rate (104,000 x 1.04) to get over £108,000.

Carry on doing this for each year of investment, and you’ll see how the amount of interest increases yearly as the overall investment grows.

After 10 years of this, you’d be looking at a final balance of around £149,000.

For the curious, compound interest is worked out with the equation [x(1+y)n - 1]-x where x is the original amount, y is the interest rate, and n is the number of years invested.

Daily vs monthly compounding: which is better?

Although daily compounding interest can result in slightly higher returns compared to monthly or yearly compounding, the difference is relatively minor.

The key elements for maximising your savings growth are the annual percentage yield (APY) and the duration of your savings.

How does compound interest help grow my investments?

Because of the ‘snowballing’ way it acts, compound interest can generate impressive returns if left to work long enough.

The higher the number of compounding periods (i.e. years invested), the more interest you will generate.

Bear in mind that this only works to full effect if you leave the investment untouched, i.e. investing for growth.

If you are investing for income, you will be drawing out the interest regularly, so it will not compound effectively.

A useful variant of compound interest is dividend reinvestment. This is when you reinvest dividend payments (which some companies pay on some shares) to buy more shares.

As with any investment, you risk losing your dividends if you choose not to cash them in.

However, carefully considered reinvestment in dividend growth stocks, or manual dividend reinvestment, can act as a ‘compounding accelerator’ to keep your money growing.

The importance of starting to invest early

Thinking about early investments is vital to enjoy maximum growth without excessive risk.

Even if you’re in your 20s, it’s wise to start your pension early to make sure you can live comfortably even after you stop working.

Starting to invest your money in relatively low-risk assets 30-40 years before you plan to retire will allow your pension pot to grow steadily over time.

In the world of compound interest, time is money.

Early investment also means you don’t have to choose high-risk investments to see substantial returns, so you’ll be less likely to lose the principal amount.

If you don’t think about investing for retirement until later in life, you’ll have to consider higher-risk options to get the same kind of returns or accept lower returns from conservative investments.

How can a financial adviser help me grow my investments?

A financial adviser can assist you in selecting the appropriate investment products and determining the optimal timeframes for investment to maximise the benefits of compound interest.

This can be particularly challenging, as it relies on your specific investment objectives and long-term plans over the next 10 to 20 years.

Unbiased can quickly connect you to a financial adviser regulated by the Financial Conduct Authority (FCA).