Compound Interest Explained (With UK Examples)

What is compound interest?

Compound interest is interest calculated on your original balance plus any interest you have already earned. Each time interest is added, the next calculation uses a larger amount — so growth accelerates over time.

This is why savings accounts, ISAs, pensions and investments talk about 'growth over time'. You are not just earning a flat percentage on your opening deposit; you are earning on an ever-growing pot.

Compound interest vs simple interest

Simple interest is charged or paid only on the original amount. If you put £10,000 in an account paying 4.5% simple interest for 10 years, you earn £450 a year every year — £4,500 total — and end up with £14,500.

Compound interest reinvests each year's interest. The same £10,000 at 4.5% compounded annually for 10 years grows to about £15,530 — roughly £1,030 more than simple interest. Over 20 years the gap widens to about £4,117.

How often is interest compounded?

UK savings accounts usually compound daily or monthly, even if they quote an annual AER (Annual Equivalent Rate). The AER already accounts for compounding frequency — two accounts with the same AER should grow similarly regardless of whether interest is credited daily or monthly.

When comparing products, use the AER rather than the gross rate. For investments and pensions, growth is typically compounded continuously or monthly as fund values rise.

• Daily compounding — interest calculated every day; common on easy-access savings.
• Monthly compounding — interest added once a month; typical on regular savers and some ISAs.
• Annual compounding — interest added once a year; more common on fixed bonds.

A worked example: lump sum savings

Suppose you put £10,000 into a Cash ISA paying 4.5% AER and leave it for 20 years without adding or withdrawing anything. With annual compounding, it grows to about £24,117 — £14,117 of pure interest.

The first five years add roughly £2,462. The last five years add about £4,800, even though the rate stays the same. That acceleration is compounding in action.

A worked example: monthly contributions

Compounding is even more powerful when you add money regularly. Saving £200 a month at 4.5% with monthly compounding builds a pot of about £30,353 after 10 years. You paid in £24,000; the remaining £6,353 is interest.

Starting with a £5,000 lump sum and then adding £200 a month for the same 10 years at 4.5% takes the total to about £38,188 — nearly £9,200 in interest on £29,000 of contributions.

The Rule of 72 — a quick mental shortcut

Divide 72 by your interest rate to estimate how many years it takes to double your money. At 4.5%, 72 ÷ 4.5 ≈ 16 years. At 6%, it takes about 12 years.

It is an approximation, not exact maths, but useful when comparing savings rates or explaining why a 1% difference in return matters over decades.

Where compound interest matters in the UK

Cash ISAs and savings accounts compound your interest tax-free (within ISA rules) or within your Personal Savings Allowance. Pensions compound tax-free inside the wrapper until you withdraw.

Credit card and loan interest also compounds — in the wrong direction. Unpaid card balances grow daily, which is why clearing high-APR debt often beats saving at low rates. See our guide on credit card interest for the borrowing side.

• Cash ISAs — tax-free compounding on savings interest.
• Workplace pensions — contributions plus tax relief compound over decades.
• Stocks & Shares ISAs — returns compound through reinvested dividends and fund growth.
• Credit cards — compound interest works against you on unpaid balances.

What reduces the power of compounding

Inflation erodes the real value of your pot even while the number on screen rises. A 4.5% return with 2% inflation gives roughly 2.5% real growth.

Tax on savings interest outside an ISA reduces net compounding — another reason ISAs matter for larger balances. Fees on investments and early withdrawal penalties on fixed accounts also eat into growth.

Model your own savings growth

Use our Compound Interest Calculator to project how a lump sum, regular contributions, or both could grow at different rates and compounding frequencies. For a single savings balance at a fixed AER, try the Savings Interest Calculator. For a target amount by a set date, use the Savings Goal Calculator.