Guide

Compound Interest Guide

A beginner-friendly walkthrough of what compound interest is, how the formula works, and how to test scenarios with clear numbers.

Published: March 10, 2025 · Updated: December 21, 2025 · By FinToolSuite Editorial

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Quick answer

Compound interest is interest on both your starting amount and the interest already earned. The three inputs that move the dial most are your rate, your time horizon, and any ongoing contributions.

See a plain definition: what compound interest is
Review the math: compound interest formula

Disclaimer

Educational purposes only; not financial advice. Results are illustrative; real returns vary and investments can go down as well as up. Taxes, fees, inflation, and account rules vary by country and provider.

Core concepts

Compounding means each period’s interest is added to the balance, so future interest is calculated on a larger amount. Time is the biggest multiplier because more periods allow more “interest on interest.”

Compared to simple interest, compound interest grows faster because prior interest stays in the balance. Simple interest would only pay on the original principal.

If you chart two paths—one with more years and one with fewer—the longer path curves upward faster. That curve steepens if the rate or compounding frequency is higher, and it flattens if either drops.

Read more on the basics: what compound interest is and the compound interest formula.

Inputs explained

Starting amount

Your initial principal. Example: £1,000.

Interest rate

Use the annual rate. APR vs APY matters if fees or compounding are included—see APR vs APY explained.

Compounding frequency

Daily, monthly, or yearly changes how often interest is added; more frequent compounding grows faster. See daily vs monthly vs yearly compounding.

Contributions

Monthly deposits (e.g., £50/month). Timing matters: earlier deposits have more time to grow. See lump sum vs monthly investing.

Time horizon

More years generally matter more than small rate changes because compounding has longer to work.

Optional factors

Fees, taxes, and inflation can reduce real growth. Many quick calculators exclude these. Adjust rate assumptions if you want a rough fee/tax buffer.

Worked examples

Example A: lump sum only

£1,000 at 5% yearly, compounded monthly, for 10 years → about £1,648.

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Example B: monthly contributions

£1,000 starting, £50/month, 5% yearly, monthly compounding, 10 years → about £8,776.

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Example C: monthly vs yearly compounding

£5,000 at 6% for 15 years → yearly compounding ≈ £12,029; monthly compounding ≈ £12,419.

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Common use cases

Saving for a goal: test timelines for a deposit schedule.
Long-term investing illustration: see how rate and time shift outcomes without predicting markets.
Comparing scenarios: run low/base/high rates or contributions to bracket results.

Read more on contribution styles: lump sum vs monthly investing. For timeline targets: how long to reach £10,000.

Common mistakes

Mixing APR and APY without adjusting the rate.
Picking a compounding frequency that doesn’t match the rate.
Using rates or timelines that are unrealistic for the goal.
Forgetting fees, taxes, or inflation when comparing scenarios.

FAQs

Is compound interest guaranteed?

No. Returns can be higher or lower, and investments can lose value.

What interest rate should I use?

Pick a rate that matches your scenario and compounding. Use “APR vs APY” guidance if fees or frequency are unclear.

Does compounding frequency matter?

Yes. More frequent compounding typically yields a slightly higher balance, especially over longer periods.

How do monthly contributions work in the model?

Each month’s deposit is added, then future interest applies to the new balance. Earlier deposits have more time to grow.

What about inflation, fees, and taxes?

They can reduce real returns. Many quick calculators exclude them; adjust your rate if you want a rough buffer.

Is simple interest different?

Yes. Simple interest pays only on the original principal; compound interest pays on principal plus prior interest.

Which is more important: rate or time?

Time often moves results more than a small rate change, because compounding repeats each period.

Can I model one-off deposits?

Yes. Enter them as a lump sum start, then set ongoing contributions if needed.

Where can I learn more about compounding?

See daily vs monthly vs yearly compounding and APR vs APY explained.

Run your scenarios

Test 2–3 different rates, timelines, and contribution amounts to bracket your illustrative outcomes.

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