How compound interest works

Compound interest is interest on your interest. You earn a return, it gets added to your balance, and the next return is worked out on that bigger balance, so the growth builds on itself. Three things decide how far it goes: how much you put in, the rate you earn, and the time you give it. Time does the heavy lifting, because the longer it runs the faster it grows.

What compound interest is

Say you put in £10,000 and earn 5% in a year. That is £500, so you now have £10,500. The following year you earn 5% on the whole £10,500, not just the original £10,000, so you earn £525. The year after that you earn 5% on £11,025, and so on. Each year you earn on a slightly larger amount, so the amount you earn keeps rising. That snowball effect is compounding.

It works the same whether you call it interest on savings or growth on an investment. It also works against you on borrowing: credit cards compound what you owe, which is why a balance left unpaid grows so quickly. Here we are talking about it working for you.

Simple interest vs compound interest

Simple interest is worked out only on the amount you started with, so you earn the same each year. Compound interest is worked out on the starting amount plus the interest already added, so what you earn grows year on year. Early on the two look almost identical. The gap widens the longer you leave the money in.

Here is £10,000 at 5% a year, with no money added and no money taken out, under each method. The figures are rounded and are estimates to show the pattern.

After one year they match. After 20 years compounding leaves you with about £6,500 more, all of it earned on interest that had already been added. To run your own figures, the compound interest calculator shows the balance year by year.

Why time matters most

Of the three levers, how much you put in, the rate, and the time, time usually does the most. Because each year builds on the last, most of the growth lands in the later years. In the example above, the £10,000 earns about £2,763 in its first five years but about £5,744 in its final five, on the same 5% rate. Nothing changed except how big the balance had already grown.

That is why starting earlier tends to beat saving more later, and why leaving money invested for the long run matters. The same logic applies to a pension, which is largely just a pot left to compound over a working life. We cover that in how pensions work.

Regular contributions add to the effect. Put away £200 a month for 20 years at 5%, compounded monthly, and you would pay in £48,000 of your own money. On these figures the pot could be worth around £82,500, with roughly £34,500 of that being growth on top of what you paid in. Again, an estimate to show the shape of it, not a promise. The savings calculator works out a regular-saving plan like this.

Compounding frequency

Compounding frequency is how often the interest gets added to your balance, for example monthly, quarterly or once a year. For the same annual rate, adding interest more often gives a slightly higher result, because the interest joins the balance sooner and starts earning sooner itself.

The effect is modest. £10,000 at 5% over 20 years grows to about £26,533 compounding once a year, or about £27,126 compounding monthly. That is a difference of roughly £593 over two decades. Worth knowing when you compare accounts, but the rate you earn and the time you give it move the result far more than how often it compounds.

One tip when comparing savings accounts: look at the AER, the annual equivalent rate. It folds the compounding frequency into a single yearly figure, so two accounts can be compared on a like-for-like basis.

The rule of 72

The rule of 72 is a quick way to estimate how long money takes to roughly double through compounding. Divide 72 by the annual rate, ignoring the per cent sign, and the answer is the approximate number of years.

• At 6% a year, 72 divided by 6 is 12, so about 12 years to double.
• At 8% a year, 72 divided by 8 is 9, so about 9 years.
• At 4% a year, 72 divided by 4 is 18, so about 18 years.

It is a mental shortcut, not an exact formula. It is most accurate for rates of around 5% to 10% and drifts a little at the extremes. For a precise figure, work it out properly rather than relying on the rule.

Nominal vs real returns

The nominal return is the headline rate you are quoted, say 5%. The real return takes inflation off that. Inflation is the rate at which prices rise, so it reduces what your money can actually buy. If your pot earns 5% in a year but prices rise 3%, your real return is roughly 2%: the balance is bigger, but it buys only a little more than before.

It matters most over long periods, exactly where compounding is doing its work. A pot that looks impressive in pounds may have grown far less in what it can buy. When you judge whether a return is doing its job, think about the real return rather than the headline rate. The rule of 72 works on real returns too: at 5% growth with 3% inflation, the 2% real return would take about 36 years to double your buying power.

Common questions

What is compound interest in simple terms?

It is earning interest on your interest. You earn a return on the money you put in, that return gets added to your balance, and next time you earn a return on the bigger balance too. Over many years the growth speeds up, because each year you are earning on a larger amount than the year before.

What is the difference between simple and compound interest?

Simple interest is worked out only on the original amount, so you earn the same each year. Compound interest is worked out on the original amount plus the interest already added, so the amount you earn grows each year. Over a long period compound interest leaves you with noticeably more.

How does the rule of 72 work?

Divide 72 by the annual rate to estimate how many years it takes your money to roughly double. At 6% a year that is about 12 years, at 8% about 9 years. It is a quick mental shortcut, most accurate for rates of around 5% to 10%, not an exact figure.

Does compounding more often make a big difference?

It makes a small difference, not a big one. For the same annual rate, compounding monthly leaves you with a little more than compounding once a year, because interest gets added sooner and starts earning sooner. On £10,000 at 5% over 20 years the gap is a few hundred pounds, not thousands. The rate and the time you give it matter far more.

What is the difference between nominal and real returns?

The nominal return is the headline rate, say 5%. The real return takes inflation off that, because rising prices reduce what your money can buy. If you earn 5% and inflation is 3%, your real return is roughly 2%. The pot still grows on paper, but it buys less than the headline figure suggests.

Are these figures guaranteed?

No. The examples here are estimates to show how compounding behaves, not a forecast. Real returns vary and are not guaranteed, a savings rate can change and an investment can fall as well as rise. This is general information, not financial advice. Check the terms of any account or product before you rely on a figure.

About this article

Written by the calcd team. We build UK money calculators and explain the numbers behind them in plain English. Compound interest is standard arithmetic rather than a tax rule, so there are no statutory figures here; we checked the concept, the rule of 72 and the nominal-versus-real distinction against MoneyHelper and the Bank of England. The figures are worked examples and estimates to show how compounding behaves, not a forecast. Real returns vary and are not guaranteed, a savings rate can change and an investment can fall as well as rise. This is general information, not financial advice. Last updated June 2026.