What is compound interest?

In part 3 of our educational series, we’re talking about compound interest and how your investments can become far more fruitful when you invest with a long term mindset.

The basics, in 60 seconds.

Compound interest is one of the secrets to many people’s fortunes.

In layman terms, compound interest is best explained as “earning interest on interest”. Over time, you earn interest on the original amount you’ve invested and on the gains that you’ve made in previous years. Again, your interest is earning interest.

Compound interest is particularly beneficial to long term investors, and can be applied across any asset class so long as the gains stay positive.

A practical example:

You invest £1000 into an investment that gains 5% annually. After your first year, your initial savings grow by 5% to £1050. In your second year, your savings pot grows by another 5%, reaching £1103. If you keep earning interest at 5% over 30 years, your £1000 investment will be worth £4321. Et voila — the power of compound interest.

This is why investing in a pension from an early age can be so beneficial. Even modest amounts of money, compounded over 30 or 40 years, can lead to surprising sums that can help you live comfortably once you’ve retired.

Even Albert Einstein was a fan

Here’s a fun fact, even Albert Einstein was an advocate for the benefits of compound interest, and was even quoted saying “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it”.

If it’s good enough for Albert, it’s good enough for us.

This explainer article is part of our ongoing education series to inform and educate the next generation of investors by explaining key investment topics. To learn more about Fountain, check us out online.