What’s compound interest? The magic of your money making more money

Ever heard the phrase "make your money work for you"? It sounds a bit like a cheesy line from a film, but it’s actually a real thing. And one of the most powerful ways to do it is with something called compound interest.

Think of it like a snowball. You start with a small one at the top of a snowy hill. As it rolls, it picks up more snow, getting bigger and bigger, and moving faster and faster all on its own. Compound interest does the same thing with your savings, but with money instead of snow.

In simple terms, it’s the interest you earn on your original savings, plus the interest you’ve already earned. It’s your money making its own money. And understanding it is a game-changer for anyone looking to save for the future – whether that’s for a house deposit, a trip around the world, or just a rainy day fund. 

How it works

Let's break it down with a simple example. Imagine you put £1,000 into a savings account that pays 5% interest per year. 

• After year 1: you'd earn £50 in interest. So you'd have £1,050. Simple enough, right?

• After year 2: here’s where the magic really kicks in. Instead of earning interest on your original £1,000, you now earn it on the whole £1,050. So, 5% of £1,050 is £52.50. Your new total is £1,102.50.

 That extra £2.50 might not sound like much, but it’s the start of your money snowball. Over time, these small amounts add up in a big way, without you having to lift a finger.

As you can see, the amount of interest you earn each year gets a little bigger. That's your money working hard for you, all thanks to the power of compounding.

The most important ingredient? Time.

The real power of compound interest comes from giving it time to work its magic. The earlier you start saving, the more time your money has to grow. Time is the single most important thing.

Let's look at two friends, Alex and Ben.

• Alex starts saving £100 a month when she’s 25.

• Ben starts saving the same amount, £100 a month, but waits until he’s 35. 

If they both save until they’re 65 and get a 5% annual return, the difference is huge:

• Alex saves £100 a month from age 25 to 65 (for 40 years).

  • This adds up to: £152,602.

• Ben saves £100 a month from age 35 to 65 (for 30 years).

  • This adds up to: £83,226

By the time they retire, Alex will have saved for 10 years longer than Ben (with £12,000 of extra payments), but her final pot will be worth almost double his. It’s not only because she saved more money each month, but because her money had a 10-year head start on the compounding journey. It’s a powerful reminder that even small, regular savings can turn into something significant if you start early.

But if you’re only just getting started, that’s okay – it’s never too late to make your money work a little harder for you. The best time to start might have been yesterday, but the second-best time is always today. 

The other side of the coin: debt

It’s also worth knowing that compound interest can work against you when it comes to debt. If you have an outstanding balance on a credit card or loan, the interest you’re charged can also compound, making the debt grow faster. It’s the same snowball effect, but rolling in the wrong direction. Understanding this can help you make smart decisions about borrowing and paying off debt as quickly as you can.

If that sounds familiar, you’re not alone – lots of people will deal with debt at some point. What matters most is understanding how it works so you can take back control. We’ve written more about how to manage debt and where to get help in this guide.

How you can get started 

Ready to put the power of compounding to work? It’s simpler than you might think.

The first step is to start saving, even if it’s just a small amount. You can do this with a savings account, where your money can begin to earn interest. With a Monzo Instant Access Savings Pot, you can start with as little as 1p and watch your money begin to grow.

The key is to be consistent and give your money time. The sooner you start, the more time that snowball has to roll.

You’ll need a Monzo Current Account. Ts&Cs apply. UK residents only.

Questions? Answers.

What’s the difference between simple and compound interest?

Simple interest is only ever calculated on your original amount. With compound interest, you earn interest on your original amount and on the interest you've already built up. It’s what helps your money grow much faster over time.

How often is interest compounded?

This depends on the account. Interest can be compounded daily, monthly, or annually. The more frequently it’s compounded, the faster your money grows, but the most important factor is still time.

Do I need a lot of money to start?

Not at all! As the example with Alex and Ben shows, starting early with small, regular amounts is more powerful than waiting to start with a big lump sum. Every little bit helps.

What kind of accounts have compound interest?

You’ll find compound interest in most savings accounts – like easy access or fixed-term ones. Monzo Instant Access Savings Pots and Cash ISAs (Individual Savings Accounts) both pay compound interest, so your money can quietly earn more while you get on with life. Cash ISAs have the added bonus of your interest being tax-free.

The taxes you pay depend on your circumstances and could change in the future. Monzo current account required. UK residents only. Ts&Cs apply.