What Is Compound Interest?
At its simplest, compound interest is the process of earning returns on your returns. Unlike simple interest, which pays you a fixed amount based solely on your original investment, compound interest allows the earnings from your investment to be reinvested and earn further returns themselves. The effect of this over time can be substantial, as your investment starts to grow exponentially, creating what is often referred to as a "snowball effect."
Let’s consider an example to illustrate this powerful concept. Suppose you invest £100,000 over 20 years, achieving a net return after costs of 8%.
Without compounding, you would simply earn 8% each year on your original £100,000, resulting in a total value of around £260,000. However, when compounding is included, that figure grows to an impressive £466,095. The difference is striking and demonstrates how compounding can multiply your wealth over time.