Compound interest calculator (UK)

How Compound Interest Works: An Example

Imagine an investor invests £1,000 in a fund, moves on with their life, and the fund grows happily at 10% per year.

The mini money snowball gains momentum over time as follows:

Year – Principal – Interest Earned at 10% – New Total
1 – £1,000 – £100 – £1,100
2 – £1,100 – £110 – £1,210
3 – £1,210 – £121 – £1,331
Note: The 10% rate was chosen simply to simplify the calculations.

You’ll earn 20% more on your savings in the third year than in the first. All without contributing any more money than the initial £1,000.

With a few more years’ gap, you’ll be earning more in annual interest than what you initially invested. (Inflation notwithstanding.)

These factors drive the return of compound interest:

• Time: Your wealth must compound over years before the snowball reaches life-changing speed. That’s why it’s helpful to start investing early.
• Interest rate: Small changes in the rate of return make a big difference to your final payout. Equities are the only asset class likely to compound at average rates high enough to generate the wealth takeoff shown by the calculator.
• Fees and taxes: Your compounding potential is limited by fees and taxes that reduce your rate of return. Choosing low-cost index funds and maximizing your ISA and SIPP will offset the fees and taxes, respectively.
• Compounding frequency: The more often interest is paid (e.g., quarterly or monthly), the faster the compounding effect will be felt.
• Please note that compound interest rates don’t just refer to the interest earned on cash.

Investment returns are also compound interest. They simply come in the form of dividends and price appreciation.

Gold can also compound as its price rises. However, it is unlikely to compound at the same rate as stocks, as the precious metal is not reflected in dividends or interest.

How to use our compound interest calculator in the UK

Here’s a brief guide to using our compound interest calculator, including how to set an interest rate suitable for UK investors:

• Initial lump sum: This is the amount you have saved or invested so far. The total balance in your ISA and SIPP accounts, for example.
• Add each year: The annual cash contributions you expect to make in the future. For example, if your pension contribution is £200 per month, add £2,400 in this field.
• Number of years: Your investment time horizon. For example, 30 years if you are 38 and calculate your potential pension fund at 68.
• Add interest: Change the number to 12 to get a monthly compounded interest rate. It’s 13 for quarterly, 52 for weekly, and 365 for daily compounding.
• Interest rate: This is your expected annual return. This is obvious for cash savings. It’s the interest rate you currently receive from the bank. But for investments, you’ll need to estimate. See below.

Fine-Tuning Your Data

You should learn how to fine-tune your expected return figures based on your portfolio’s asset mix. This will ensure you’re entering a reasonable growth rate in the “interest rate” box.

Another option is to calculate your own expected return using the Gordon Equation. It’s surprisingly simple.

Read our detailed analysis of the pros and cons of a standard 60/40 stock-bond allocation to see how to estimate your expected bond returns.

Keep in mind that none of these methods can predict your personal outcome. Investing is too unpredictable to offer precision.

Expected returns can be more accurate than historical returns, but they are unpredictable. Even ten to fifteen years is a relatively short time horizon in investing.

Extend Your Time Horizons
The longer the period, the greater the likelihood that investment returns will converge with their historical average.

That’s why it’s advisable to use both historical and expected returns when calculating an investment horizon of 30, 40 years, or more.

In fact, it’s advisable to use both expected and historical returns. This way, you have a wider range of outcomes to plan for.

Finally, if you find a data source for nominal returns (i.e., unadjusted returns), first subtract the UK’s long-term average inflation rate.

For example, subtract 3% of average UK inflation from a nominal return of 8%. Then, add 5% compound interest to get an inflation-adjusted result.

Compound Interest for Billionaires

Time is on the side of compound interest. That’s why it’s so beneficial to start investing early.

But even if you’re older, don’t underestimate how compounding can boost your returns if you live long enough.

Just think of everyone’s favorite investor, Warren Buffett.

Buffett is one of the richest people in the world: at last count, his fortune stands at $163 billion, despite having donated at least $55 billion to charity since 2016.

However, it’s surprising that almost all of this vast wealth was added to Buffett’s own after he turned 65.

In his book “The Psychology of Money,” author Morgan House did the math and found that 99% of Buffett’s wealth was accumulated after the Sage of Omaha was old enough to access Social Security.

“That’s how compounding works,” Housel reminds us. “If Buffett retired at 65, you would never have heard of him.”

More Inspirational Quotes on Compound Interest

“Money makes money. And money that makes money, makes money.”

• Benjamin Franklin

“My wealth comes from a combination of American living, lucky genetics, and compound interest.”

• Warren Buffett

“The first rule of compound interest: never interrupt unnecessarily.”

• Charlie Munger

“The pursuit of sustainable, uninterrupted compound interest over the long term is smart investing, and that’s our goal. Many consider us “value investors,” while others wonder if we’re value or growth investors. We’ve started saying we’re neither: we’re compound investors.”

• Chuck Acres

“The tyranny of compound interest costs can ruin the miracle of compound returns.”

• John Bogle

“Relatively small differences in compounded annual returns over many years lead to dramatic differences in terminal wealth.”

• Nick Train

“Compounding is the magic of investing.” – Jim Rogers

“Think of the Native Americans of Manhattan, who in 1626 sold all their property to a group of immigrants for $24 worth of trinkets and beads. For 362 years, the Native Americans have been cruelly mocked for this, but it turns out they might have gotten a better deal than the buyers who acquired the island. At 8% interest on $24 (note: let’s suspend our disbelief and assume they converted the trinkets into cash), over all those years, the Native Americans would have accumulated a net worth of just under $30 trillion, while Manhattan borough tax records show the real estate holdings are worth only $28.1 billion. Give Manhattan the benefit of the doubt: $28.1 billion is the assessed value, and for all we know, it could be worth twice that on the open market. In any case, the Native Americans could have had a net worth.” $29 trillion or more… What a difference! It could be a few percentage points, three… centuries of growth.” – Peter Lynch

“Compound interest is the most powerful force in the universe.”

• Albert Einstein (maybe)

“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t, pays it.”

• Albert Einstein (unlikely to say)

Happy compounding!