What is compound interest and how can it boost your earnings?

Whether you’re investing for your retirement, a new home or your children’s future, compound interest can help you reach your financial goals faster. It’s effect means that even small changes in what you put away each month can make a huge difference to your earnings over time. To help you understand how, we take a look at how it works and what it could mean for you.

What is compound interest?

Compound interest can help boost your earnings over time. Here is a basic example of how it works.

Say you have an investment of £10,000 and earn interest at 5% per year, your balance would go up as follows:

Year 1

Interest added = 5% of £10,000 = £500

Total balance = £10,500

Year 2

Interest added = 5% of £10,500 = £525

Total balance = £11,025

Year 3

Interest added = 5% of £11,025 = £551.25

Total balance = £11,576.25

You can see the amount of interest that gets added each year goes up, as you are effectively earning interest on your interest. This is what is meant by compound interest.

Regular contributions can help accelerate your earnings

Naturally, putting money aside each month means you’ll have more in your account. However, regular payments will also help you earn more interest. The more money there is in your account, the more interest it will gather, and the more compound interest you’ll earn on top of that.  

If you started with £10,000, here’s an example of what you could earn on the Balanced lending option with regular monthly payments:

As you can see, the amount of interest you could earn goes up rapidly with bigger monthly payments. A simple way to make regular payments into your account is to set up a standing order. Find out how here.

Think long term for bigger returns

When you start to look long term, compound interest can help your earnings grow exponentially. The difference can be really quite remarkable. Here’s an example of what you could earn on the Balanced lending option if you started with £10,000 and added £100 each month.

20-30 years may seem like a long time, but if you’re planning for your retirement or a nest egg for your children, it may be a realistic timeline. The sooner you start, the sooner you’ll start benefiting from your compound interest. The increases in what you could earn get bigger and bigger over time. This is all thanks to compound interest. By earning interest on your interest over many years, your earning potential rises dramatically. After 16 years you could have doubled your money. After 30 years, you could have more than tripled it.

Keep lending switched on

When you receive repayments from businesses, our lending tool will automatically lend them out again to other businesses. By keeping lending active, you’ll be able to gain even more from compound interest. All you have to do is keep lending switched on for your account. If you have lending paused, you can start lending again from the Lending settings page of your account.

To add funds to your account login here, or learn how to set up a standing order. By lending to businesses your capital is at risk and funds are not covered by the Financial Services Compensation Scheme

Enjoy lending!

These figures are estimates based on lending an initial £10,000 through the Balanced lending option, earning a return of 6% per year. They were calculated using a compound interest calculator. The projected return for the Balanced lending option is 6-7% per year after fees and bad debt, but before tax. Your actual return may be higher or lower. Please note, forecasts are not a reliable indicator of future performance and your capital is at risk.

This blog is a general summary, and should not replace financial advice tailored to your specific circumstances. Funding Circle is not authorised to, and does not, provide investment, tax, legal or regulatory advice. If you have any questions, please speak to your professional advisor or seek independent specialist advice.