Compound interest is the process of earning interest on your interest — your returns generate their own returns, which generate their own returns, building on itself exponentially over time. Over long periods, the difference between simple and compound growth is staggering.
Simple vs. Compound: The Core Difference
Simple interest earns only on the original principal. £10,000 at 7% simple interest earns £700 every year — always on the same base.
Compound interest earns on principal plus accumulated interest. Year one: £700. Year two: £749. Year three: £801. Each year's base grows.
The Formula
The Same £10,000 Over 30 Years
The Rule of 72
Divide 72 by your annual return rate to find how many years it takes to double your money:
- 6% → doubles every 12 years
- 8% → doubles every 9 years
- 10% → doubles every 7.2 years
- 12% → doubles every 6 years
Time Is the Most Powerful Variable
Consider two investors, both earning 8% annually:
- Alice invests £200/month aged 22–32 (10 years). Total invested: £24,000.
- Bob invests £200/month aged 32–62 (30 years). Total invested: £72,000.
By age 62 — Alice has £349,888. Bob has £272,126. Alice wins by £77,000 despite investing £48,000 less. The only difference: she started 10 years earlier.
Compound Interest Works Against You Too
A £5,000 credit card balance at 20% APR, on minimum payments, takes over 25 years to repay and costs more than £10,000 in interest. The same maths that builds wealth destroys it when you're the borrower. Eliminating high-interest debt is the highest guaranteed "return" available.