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Compound interest is one of the most powerful ideas in personal finance, and one of the simplest. It means you earn interest not only on the money you put in, but also on the interest you've already earned. Over a few months the effect is small. Over decades it can be the difference between a modest pot and a substantial one.

This guide explains how compound interest works, how UK banks quote it, and how to use it to your advantage. You can see the numbers for your own savings with our compound interest calculator.

Simple interest vs compound interest

With simple interest, you earn interest only on your original deposit. Put £10,000 in an account paying 5% simple interest and you'd earn £500 every year. After 20 years you'd have £20,000.

With compound interest, each year's interest is added to your balance, and next year's interest is calculated on the larger amount. The same £10,000 at 5% compounded once a year grows to about £26,533 after 20 years. The extra £6,533 is interest earned on interest.

The gap starts small and then widens faster and faster. That's why time is the most important ingredient.

How compounding frequency affects your returns

Interest can be added daily, monthly, quarterly or annually. The more often it's added, the sooner it starts earning interest of its own. In the UK, savings accounts must quote an AER (annual equivalent rate), which shows what you'd earn over a year once compounding is taken into account. Because AER already includes the effect of compounding, it's the best figure to compare accounts with.

You may also see a gross rate, which is the rate before tax and before compounding. Two accounts with the same gross rate but different compounding frequencies will have slightly different AERs.

Adding regular deposits

Compound interest becomes even more effective when you keep adding money. Saving a regular amount each month means every deposit starts compounding as soon as it lands.

For example, starting with £5,000 and adding £200 a month at 4% AER, you'd have about £36,740 after 10 years. You'd have paid in £29,000, so roughly £7,740 of that is interest. Try changing the monthly amount in the compound interest calculator to see how much difference an extra £50 a month makes.

The rule of 72

A quick way to estimate how long it takes money to double is the rule of 72. Divide 72 by the annual interest rate:

• At 3%, money doubles in about 24 years.
• At 4%, about 18 years.
• At 6%, about 12 years.
• At 8%, about 9 years.

It's an approximation, but it's a handy way to compare options in your head.

Compound interest works against you on debt

The same maths that grows savings also grows debt. Credit cards and many loans charge interest on unpaid interest, which is why balances can climb quickly if you only make minimum payments. Paying off high-interest debt is often the best "return" available, because clearing a card charging 25% saves far more than a savings account can earn.

Inflation: the hidden opponent

Compound interest makes your balance grow, but inflation reduces what each pound can buy. If your savings earn 4% while prices rise by 3%, your real return is only around 1%. Over long periods, money left in low-interest accounts can lose spending power even as the balance rises.

For goals more than five years away, many people consider investing in stocks and shares, which have historically grown faster than inflation over long periods but can fall in value along the way. That's a personal decision, and it's worth getting regulated financial advice if you're unsure.

Tax on interest in the UK

Interest from savings accounts counts as income. Most people can earn some interest tax-free thanks to the Personal Savings Allowance: £1,000 a year for basic-rate taxpayers and £500 for higher-rate taxpayers. Additional-rate taxpayers don't get an allowance. Some people on low incomes can also use the starting rate for savings.

Interest earned inside an ISA is completely tax-free and doesn't count towards your allowance. You can pay up to £20,000 a year into ISAs in the 2026/27 tax year. The government has announced that from April 2027 the cash ISA limit will fall to £12,000 a year for people under 65, while the overall ISA allowance stays at £20,000. Our guide to savings interest and tax explains the allowances in more detail.

Five ways to make compounding work harder

1. Start early. Time does more of the work than the amount you save. Ten extra years can matter more than doubling your contributions.
2. Save regularly. A standing order on payday turns saving into a habit and gives each deposit longer to grow.
3. Leave the interest in. Withdrawing interest stops it compounding.
4. Compare AERs and switch. Loyalty rarely pays. Moving to a better rate is one of the easiest wins available.
5. Use your tax-free allowances. An ISA or pension lets more of your returns compound without being taxed.