Deep Dive

WTF is Compound Interest?

Emma Nunes-Vaz
January 16, 2024

Next in our WTF series is compound interest - so sit back, relax and get ready to expand your financial horizons 😎

To put it simply, compound interest is when you earn interest on your investment, with that interest then beginning to earn interest itself. In other words, it’s the accumulation of interest you earn from your original deposit combined with the interest you’ve earned so far. This can be a great way to boost your earnings, but it's important to understand how it works before you get started 👀

The official formula for compound interest is as follows…

Don’t worry, I just see random letters too 🙃 Let’s simplify it Incredible style 😎 

Let's say you invest £100 into a savings account that pays 2% interest per year. After one year, you would have £102 in your account; yet in the second year, you would not only earn interest on your original £100 investment - but also on the £2 that you earned in interest the first year; meaning you would have £104.04 at the end of the second year. Compound interest can therefore help your money grow more quickly than if you were just earning interest on your original investment. However, it's important to remember that compound interest also works in the reverse - if you have debt with compound interest, it can quickly spiral out of control. This is as the amount you owe will grow each time the interest compounds, therefore making your payments larger over time. 

If you're looking to invest your money and take advantage of compound interest, there are a few things to keep in mind. First, you'll want to choose an investment that has a higher interest rate, allowing your money to grow more quickly. You'll also want to make sure that you're comfortable with the risk involved in any investment - you’ll know from our blog on investing that you can just as easily lose money as you can make it. Using compound interest is the same - it can produce great returns, but there's always the potential for loss. Be sure to do your research and understand the investment before you get started!

Finally, remember that compound interest is a tool - it's not a magic wand. It can help you grow your money more quickly, but it's important to have realistic expectations and to be patient; and not to forget that it can lead to a large financial loss as well as gain. Investing is a long-term game (usually 5 years+), and compound interest can be a great way to boost your earnings over time. However it’s important to stay on top of any debts you have with or without compound interest, preventing them from taking control of your life. With Incredible this is easier than ever; as we automate and optimise your repayments all in one easy app - giving you back control of your finances 😉