The Power of Compound Interest

Simple interest pays you on your original deposit. Compound interest pays you on your original deposit plus the interest you've already earned. That difference, small at first, becomes enormous over time.

The numbers

£10,000 at 7% simple interest for 30 years: £31,000. The same £10,000 at 7% compound interest for 30 years: £76,123. The extra £45,000 came from doing nothing differently except letting interest earn interest.

The Rule of 72

To estimate how long it takes for money to double, divide 72 by the annual return. At 6%: 72 ÷ 6 = 12 years to double. At 9%: 72 ÷ 9 = 8 years. At 3% (a cash savings account): 72 ÷ 3 = 24 years. This is why equity investment — with historically higher returns — compresses the doubling time significantly.

The compounding enemy: inflation

Inflation erodes purchasing power. If inflation runs at 3% and your savings account pays 2%, you are losing 1% of your real purchasing power every year. This is why cash savings, while important for an emergency fund, are not a long-term wealth strategy. The goal is to beat inflation consistently over decades.

Alice and Bob

Alice invests £200/month from age 25 to 35, then stops. Bob invests £200/month from age 35 to 65. Alice invests for 10 years; Bob invests for 30 years. At 7% annual return, Alice ends up with more money. Not because she was smarter — because she started earlier. The 10 years of early compounding outweigh Bob's 30 years of contributions.

The cost of waiting

Every year you delay starting is not just a missed year of contributions — it's a missing year at the start of the compounding curve, where each year of delay costs you more than the last. At age 25, £100/month invested for 40 years at 7% = £262,000. Starting at 35 instead (30 years): £122,000. The 10-year delay costs £140,000.

The contribution size myth

"I can't afford to invest properly." £50/month is not nothing. At 7% for 30 years, it becomes £60,000. Start small, start now, increase contributions as income grows. The most important investment decision is making the first one.

The ISA

An Individual Savings Account (ISA) is a tax-free wrapper. Any growth or income inside an ISA is not subject to capital gains tax or income tax — ever, on withdrawal. The annual allowance in 2024/25 is £20,000. There are several types: Cash ISA (savings, interest tax-free), Stocks & Shares ISA (investments, gains and dividends tax-free), Lifetime ISA (up to £4,000/year for first home or retirement, government adds 25% bonus).

The pension

A pension is the most tax-efficient savings vehicle available. Contributions receive tax relief at your marginal rate — a basic-rate taxpayer gets 20% added by HMRC for every pound contributed. Higher-rate taxpayers get 40%. Employer contributions are also tax-free and are essentially free money that forms part of your employment package. Auto-enrolment means most employed workers are now in a workplace pension by default — check yours is invested in a sensible fund.

ISA vs pension

Both are tax-efficient. The difference is access: you can access ISA money at any time; pension money is locked until age 57 (rising to 58 in 2028). The rule of thumb: use your pension for retirement savings (especially to capture employer contributions), and your ISA for medium-term goals or flexibility.