What is compound interest?
Compound interest is a very common concept in the world of finance, and refers to the interest on savings being applied based on the initial sum as well as the accumulated interest from previous periods. It can be thought of as earning interest on interest, meaning a pot of money can grow quicker than with standard interest.
The rate of interest accrued depends on the period set, whether that’s annual, quarterly, or monthly, for example. Naturally, with a more frequent interest period, such as every month, the amount accumulated would go up faster, earning more money more rapidly.
Key takeaways from this section:
- Compound interest on savings is worked out based on the initial deposit plus all the interest already accumulated.
- The rate of compounding depends on the frequency of the period, such as monthly or annually.
- Make the most of compound interest by saving early and leaving the amount untouched for as long as possible
- Compound interest can work against you when borrowing, such as debt quickly building up on a credit card when the full amount isn’t paid off.
Compound interest explained
As an individual saver or an investor, compound interest can work in your favour if you know how to make the most of it. Compound interest can help savings and investments grow very successfully, and even protect against wealth-eroding factors such as inflation and increases in the cost of living.
Keep in mind that it can also work against you when it comes to borrowing money, such as a credit card that makes use of compound interest for monthly repayments. With interest on a debt compounding every month, it would very quickly increase the overall amount owed.
To really make the most of compound interest to grow your money, you need to start saving early and leave it untouched for as long as possible. Compound interest can keep a pot of money growing exponentially even if you don’t make another deposit, but it needs the time to really build up a substantial return.
This is what makes compound interest so powerful, as you can build up savings without needing to add to it beyond the initial deposit.
How compound interest works
To put the concept of compound interest into practice, if you had £1000 in a bank account with an interest rate of 10%, after a year you would accumulate £100 of interest. In the next year, you would then earn £110 of interest, based on the initial deposit of £1000 plus 10% of the interest you earned on it.
The power of compound interest can be shown even more effectively if we think about it in terms of saving over a long period. If you set up a savings account at the age of 30 and put aside £50 a month, with 10% annual interest you’d have £104,015 by the time you turned 60.
If you started this even earlier and saved £50 a month from the age of 20 to 30, and then just left the money untouched until you turned 60, you’d have the much greater sum of £176,640. Starting early and putting money aside for less time can actually earn you more in the long run with compound interest, so long as you give it sufficient time for the money to build.
The formula for compound interest
To work out compound interest, the formula is P = C (1 + r/n)nt . C is the initial deposit, r is the interest rate, n is how frequently interest is paid, and t is how many years the money is invested. P represents the resulting value of your savings.
Thankfully there are plenty of compound interest calculators to be found online, so it’s fairly straightforward to get an idea of what you could earn on your savings.
The rule of 72
The rule of 72 is a method of quickly making an estimate of how long it would take to double your money when investing with compound interest. To do this you need to multiply the number of years by the interest rate to try and get 72. Or rather you divide 72 by the interest rate to see how many years it would take to double your money.
For example, if you have £1000 and an annual interest rate of 5%, you divide 72 by 5 to give you 14.4, meaning it will take roughly 14 and a half years to double your money.
Compound interest FAQ's
Why is compound interest so powerful?
Compound interest can be so powerful because it effectively fuels its own growth. A savings fund will keep growing exponentially even if you never add more funds to it after the initial deposit, as each interest period paid includes interest on all the previous periods as well as the initial sum.
Can compound interest make you rich?
Compound interest can be an effective way to grow wealth, as the interest is earned on top of interest already earned. Naturally the amount you grow will depend on the initial sum invested and the length of time the fund has to grow, as well as the interest rate and the frequency of interest periods
Have you thought about Invoice Finance as a cash flow solution for your business?
Invoice finance allows you to release cash quickly from your unpaid invoices.
As your lender, we can release up to 90% of your invoices within 24 hours. On payment of the invoice from your customers, we will then release the final amount minus any fees and charges. There are different types of invoice financing options available to businesses depending on the situation and the level of control they require in collecting unpaid invoices.
We are an invoice financing company who offer a solution whereby payments are collected on your behalf managed by our team of expert credit controllers so you can focus on running your business. Our Confidential Invoice Discounting solution is offered to businesses who want to maintain their own credit control processes, therefore this remains strictly confidential so your customers are unaware of our involvement.
The benefits of invoice finance companies such as Novuna Business cash flow
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We explore ways you can begin improving your cash flow situation and start getting your business on track to positive cash flow.
Competent staff, slick technology. Would recommend
Halo is one of the smartest bits of tech I have seen & every team is only as good a it's people and I would like to take this time to actually specifically point out Alex Hall & Claire Davies. Alex is an account manager that has continually improved during our time working together and is a real credit to Novuna. Claire has been exceptional from start to finish; meticulous in her work and very patient with us at every temp - an absolute star. It is a shame that the email address went to a generic platform and not each individual. I totally understand why this works better for companies but it did mean that the personal element was lost meaning that starts like Claire will be harder to identify from a customer point of view.
High recommedation for Novuna Business Cashflow.
My company was in need of invoice factoring to assist with the cashflow due to the nature of debtor days with our clients. After looking at a number of options, the right decision was made to work in partnership with Novuna Business Cashflow. Right from setup through sales to customer service, the communication and support has been outstanding. Providing me with all the information I needed regarding new clients coming onto our books. The system they use is so user friendly and the drawdown payments are very efficient in the fast moving world of temporary payroll. This has allowed my company to look at positive growth knowing we are safe financial hands. I would highly recommend Novuna Business Cashflow 10/10.
Set up went well and communication was good.
Syed and Vipul were extremely helpful top class service
Very helpful from the start
Great people made this process very straightforward.
Jemma from Novuna (formally Hitachi) was brilliant. Worked with us throughout the process and succeeded when some others had failed. Carried out the necessary checks with a smile and cheery demeanour, making what would have been a laborious process quite manageable.
Teething problems -Maybe ?
It's still early days so I may alter this review at a later date. However with retentions and concentration limits and other items, were finding were not getting 85% up front, were probably getting nearer 70% Also when a customer pays the remaining allegedly 15% due to us seems not to be credited to become available. For instance a customer paid Â£6918 and a customer paid Â£1300 hence we should see an extra Â£1330 available (15% of both these payments). However availability seemed to go down and not up by Â£1330 !!! Hard to work out where this 15% has actually gone ? I'll re-submit this review when things become clearer.
I found Hitachi true to their world in every aspect of the service they promised. I can't recommend enough.
Excellent Customer care and service.
Excellent customer service from start of initial conversations, right through to finally becoming a customer. The whole team involved are a credit to Hitachi, they were accommodating and informative the whole way along the process. I would highly recommend Hitachi to future clients and business associates. Thanks Alan.
I really enjoyed working with the Hitachi team, professional, helpful and really good people to deal with. They have made what could have been a very difficult experience a pleasure. Very happy to recommend them.
Hitachi made the process of moving factoring facilities painless, bearing in mind we previously had our facility with the same provider since 1997. I cant fault Hitachi's staff and processes and we are delighted with the move.
Staff excellent all together professional
Great service so far
From start to finish the process for transferring our invoice finance to Hitachi has been been brilliant, a smooth transition, great communication our link Person Jonathan Oakes has helped the process go through seamlessly, A great experience so far and a brilliant start to what we hope will be a long term partnership.