Read more: CPI vs RPI inflation: what’s the difference? Why is compounding so powerful? If you’re invested for more than a year, you multiply the figure by the number of years. To calculate the simple interest earned you multiply the original sum by the interest rate in order to get the amount of interest earned per year. It’s easier to calculate than the compound interest formula. It doesn’t include the interest you have earned on interest. Simple interest is that which is generated on the initial amount that you saved or borrowed. Read more: Best savings accounts in 2023 What is the difference between compound interest and simple interest? The investment platform Nutmeg has a compound interest calculator you could try to see the power of compounding over time. There are plenty of tools online that can help you work out compound interest. Read more: Best reward credit cards How to calculate compound interestĬompound interest is calculated using both the principal sum of money plus the interest generated over time. If you are struggling with credit card debt, we have more about consolidating debt and where to go for debt help. It could take years to clear your debt, which is why it is important to understand how interest repayments work before taking on debt. Just as a small amount of savings can grow over time without you adding any more money to the pot, a small debt can also grow without you spending any more money. Not only do you owe the original amount that you borrowed to the lender but you also have to pay a hefty interest rate on top. The average interest rate on a credit card reached a 16 year high at the end of 2022, hitting a hefty 30.3%. When you make repayments on your credit card you pay back interest on the original debt, but also on the interest that is accrued. While compound interest is a saver’s best friend, it can be a borrower’s worst nightmare. Read more: Investing for beginners guide How does compound interest work on credit card debt? If you’re unsure about investing, seek independent financial advice. Even if you benefit from compounding at times, you could get back less than you invest. Remember: your investments can go up as well as down. If you are investing for income, where you regularly skim off the interest you earn, you will not benefit from compounding. This can only work if you invest for growth, which is when you leave your money invested for a number of years. This is because every year there is a larger sum to earn that interest. If you are saving or investing, compound interest will increase the amount by which your money grows every year. Read more: What do UK interest rate rises mean for you? How does compound interest work on savings and investments? So you could end up with either a boulder-sized pot of cash or a boulder-sized pot debt to repay. This means that not only are your savings growing over time, but the rate at which they grow gets faster as well.īut remember that the same can apply to money you borrow too, with the snowball effect making your debt larger. Year 3: interest is earned on your initial deposit, plus interest earned in both year 1 and year 2.Year 2: interest is earned on your initial deposit, plus interest earned in year 1.Year 1: interest is earned on your initial deposit.Over time, you earn interest on the initial sum of money saved, as well as the interest itself: Understanding the principle, formula, and how it is calculated can make a big difference to your finances. The term is often used in relation to both savings and investments as well as loans and debt. This is how the principle of compound interest works. It starts the size of a small rock, but every rotation picks up a bit more snow until it is the size of a boulder when it reaches the bottom. Imagine a snowball rolling down a mountain. It is essentially the interest that you can earn from your interest. Read more: Investing for beginners course: module one What is compound interest? How does compound interest work on credit card debt?.How does compound interest work on savings and investments?.Just as compound interest can accelerate the growth of your savings and investments, it can have the same effect on your debts too. Confused by compound interest and how it works? We explain what it is and how it’s calculated.
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