Guide
What Is Compound Interest?
Compound interest means earning interest on both your starting amount and the interest already earned. Time and contributions make the effect stronger.
Published: March 11, 2025 · Updated: December 21, 2025 · By FinToolSuite Editorial
Quick answer
Compound interest adds interest to your balance, then calculates future interest on that larger amount. It matters because the balance can grow faster over time.
Next: see the 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. Fees, taxes, inflation, and account rules vary by provider and country.
How compound interest works
Each period, the balance earns interest. That interest is added to the balance, so the next period starts from a slightly larger amount. Over multiple periods, the effect stacks.
Tiny progression at 5% yearly, £1,000 start (simple illustration):
| Year | Start | Interest | End |
|---|---|---|---|
| 1 | £1,000 | £50 | £1,050 |
| 2 | £1,050 | £52.50 | £1,102.50 |
| 3 | £1,102.50 | £55.13 | £1,157.63 |
Time accelerates the effect because each year starts from a slightly higher base.
Why time matters
Compounding often looks slow at first, then faster later, because interest is applied to a growing balance. More years usually matter more than a small change in rate.
- Early years: growth is steady, mainly from principal.
- Middle years: interest starts to meaningfully add to the base.
- Later years: interest-on-interest can dominate the change.
Simple comparison at 5% yearly, £1,000 start, yearly compounding:
| Horizon | Approx. end balance |
|---|---|
| 5 years | ~£1,276 |
| 20 years | ~£2,653 |
Two worked examples
Example A: lump sum only
£1,000 at 5% yearly, monthly compounding, 10 years → about £1,648.
Try this in the calculatorExample B: with monthly contributions
£1,000 start + £50/month, 5% yearly, monthly compounding, 10 years → about £8,776.
Try this in the calculatorCommon questions and misconceptions
- Is compound interest guaranteed? No—returns can vary and balances can fall.
- Does compounding frequency matter? Yes—more frequent compounding can give a slightly higher balance over time.
- Is this the same as APR/APY? APR is the nominal rate; APY includes compounding and timing. See the formula and simple vs compound interest.
FAQs
What is compound interest in simple terms?
It’s interest applied to both your original amount and any interest already earned.
How is it different from simple interest?
Simple interest pays only on the principal; compound interest pays on principal plus prior interest. See simple vs compound interest.
Why does time matter so much?
More periods give more chances for interest to be added to the balance, which can speed up growth later on.
What’s the compound interest formula?
A = P(1 + r/n)^(n·t). See the compound interest formula for a breakdown.
Does monthly vs yearly compounding make a big difference?
Monthly compounding can end slightly higher than yearly, especially over long periods, because interest is added more often.
How do monthly contributions change results?
They add more principal over time, and each deposit can earn interest for the remaining periods.
Do fees and taxes change the outcome?
Yes. They can reduce the effective rate. Quick calculators often exclude them, so adjust your rate if you want a rough buffer.
Can I use this for short-term goals?
Yes, but short horizons rely more on contributions than on compounding. Run a scenario for your timeline.
Run your scenarios
Try a conservative and a base scenario in the calculator to bracket your illustrative outcomes.
Open the calculator