Compound interest can be a game-changer when it comes to growing your savings pot. Once you understand the benefits of compound interest, you’ll soon feel ready to reap its rewards.
A short definition of compound interest
Compound interest refers to the ability to earn interest on previously earned interest. That may sound complicated, but it’s a straightforward concept once you understand it.
With compound interest, the funds in your savings account will earn interest on the accumulated interest from the previous year. This means as your savings grows in value, the rate at which they grow does too. This compounding effect can boost the amount of interest you earn, making it a simple way to grow your savings.
The key benefits of compound interest
Compound interest can be a powerful tool in growing your savings. Here are just some of the key benefits of compound interest.
1. Your savings can grow faster
Compound interest helps your money grow faster. It's like a snowball effect – your savings increase, and so does the interest you earn. This continuous cycle has the potential to increase your savings more quickly than they would with simple interest.
Let's break down how compound interest works with a practical example:
Initial deposit: You start with a £5,000 deposit into a savings account.
Annual interest rate: The account offers a 5% (0.05) annual interest rate.
- Interest earned in the first year: £5,000 x 0.05 = £250
- Total savings after the first year: £5,000 + £250 = £5,250
- Interest earned in the second year: £5,250 x 0.05 = £262.50
- Total savings after the second year: £5,250 + £262.50 = £5,512.50
This continuous cycle of earning interest on both the initial deposit and the accumulated interest from previous periods is what makes compound interest a powerful tool for growing your savings over time.
Take a look at our guide to compound interest for more information.
2. Long-term growth
By being strategic with your financial planning, you’ll soon see the power compound interest can have over longer periods of time. The more time your savings have to compound, the more wealth you can accumulate.
This reiterates the importance of saving as a long-term investment. The earlier you get started, the more benefits you’ll receive. Compound interest works in your favour by increasing the value of your savings without any extra effort on your part.
3. Reduces risk
Compound interest can help ride the waves of inflation and economic changes. If your savings don’t grow at the same rate as inflation, the real value of your money diminishes. You may not be able to buy the same amount of goods and services in the future as you could with the same amount of money today.
But compound interest can help your funds grow in value, preserving your wealth and enhancing purchasing power. It’s also worth considering factors such as the interest rate, frequency of compounding, and impact of tax.
4. Encourages long-term planning
Understanding the power of compound interest can encourage you to adopt a long-term perspective when it comes to saving and financial goals. If you’re looking to reach a savings goal, compound interest can motivate you to commit to saving early and often, rewarding you with more interest the longer you save.
For more information on how interest rates work, take a look at our savings and investments guide to interest rates.
How Flagstone can help you grow your savings
If you’re looking to benefit from compound interest to maximise the return on your savings, Flagstone can do the hard work for you. Our cash deposit platform offers you access to hundreds of accounts from over 60 banks, including exclusive interest rates.
You can spread your cash across different banks, all from one place. This allows you to move your money around easily without completing separate applications. By opening several accounts, you can maximise interest, get the greatest FSCS protection, and support your financial future.
See how much interest you could be earning with our calculator today.