What Is Compound Interest??
Compound interest is the process where interest is earned on both the initial investment and the accumulated interest from previous periods. This can result in exponential growth of your investment over time. For example, if you invest £1000 at a 5% annual interest rate, you will earn £50 in interest during the first year. In the second year, you will earn interest on the original £1000 and the £50 in interest from the first year, for a total of £1025.50. This process continues and your investment grows exponentially.
To illustrate the power of compound interest, let’s say you invest £1000 at a 5% annual interest rate for 10 years. Using the compound interest formula, we can calculate that your investment would be worth £1,628.89 at the end of the 10-year period. Now, if you invest for 20 years instead, your investment would be worth £2,653.33 at the end of the 20-year period. This is more than £1,000 higher than the value of your investment after 10 years, despite the fact that you only earned an additional 10 years of interest.
The longer the investment period and the higher the interest rate, the greater the potential for compound interest to grow your investment. For instance, if you invest £1000 at a 10% annual interest rate for 20 years, your investment would be worth £6,727.72 at the end of the period. This is more than four times the value of your investment at a 5% interest rate over the same period.
It can also work against you if you have outstanding debt. For example, if you have a high-interest credit card, the interest that you owe will be compounded over time, making it more difficult to pay off your balance. This is why it’s important to manage your debt carefully and pay off any high-interest debt as soon as possible.
Compound interest is a powerful tool that can help your money grow over time. By investing for longer periods and at higher interest rates, you can potentially earn significant returns on your investment. Speak with one of our BlueSphere financial advisers for more information.