Compound Interest: The Highs and Lows

Compound interest is a financial term that refers to the way interest accumulates against borrowing or is earned against savings. It is therefore equally associated with borrowing products, including loans and credit cards, as well as with savings accounts and investments.

While the principles of interest-led growth or the downsides of cumulating interest costs are fairly uncomplicated, the key is to understand how compound interest works to ensure you make astute decisions, such as calculating the cost of financing accurately, and identifying the best ways to maximise the value of your savings.

In this article, our experts at Chase Buchanan Private Wealth Management address some common misunderstandings by explaining how compound interest works, and why it can be an investor’s best friend, yet a borrower’s worst nightmare.

What Is Compound Interest and How Does It Work?

The technicality of compound interest belies a simple concept, and it works the same way regardless of the product to which it is applied.

On a debt or savings product, any interest you earn or owe is added to the original balance. Whether you’re gaining it or paying it, the next batch of interest is calculated against the new total, which comprises the initial value plus the interest earned or charged since the last time the interest was calculated.

Therefore, the distinct advantage of compound interest is that the longer you hold savings, the more they will grow, and at an increasing rate over time. Provided there isn’t a limit on the amount of compound interest an account accumulates, you can multiply your savings many times over if they are held for long enough.

Conversely, compound interest can create serious concerns for those in debt or make financing products significantly more expensive, especially if the borrower isn’t making consistent repayments.

We’ll explore both of these situations further below, but it’s important to understand that just as compound interest can maximise savings, it can also multiply debts.

The Disadvantages of Compound Interest for Borrowers

Compound interest applies to a broad range of credit facilities, including loans, credit cards, asset finance, and other personal or commercial borrowing products. Compounding can occur annually, monthly, quarterly, or even daily, which can substantially change the affordability of a credit account.

Student loans are a real-world example of the risks of compound interest, and how an accumulating balance can potentially overtake repayments, with the balance owing growing larger with each passing period.

For example:

• A student has university fees of £10,000 per year, charged via a student loan account with interest of 5% per annum (simplified for illustration purposes).
• Their course lasts for three years, with fees beginning from year one, and they don’t need to make repayments until the year after the course finishes.
• In year one, they are charged £10,000 plus a 5% interest charge, creating a debt of £10,500.
• By the end of year two, they have incurred a second £10,000 fee, plus 5% interest, including the year one debt of £10,500, so the balance is now £21,525, compared to course costs of only £20,000.

When the student finishes the course at the end of year three, their debt stands at £33,101.25;  £30,000 in course fees and over £3,000 in compound interest.

Depending on how quickly they make repayments, and of what value, the same 5% will then be added to this debt year-on-year. This is a reality for many families managing student finances, and in many cases, compound interest is calculated daily rather than annually.

The Benefits of Using Compound Interest to Grow Savings Wealth

Much as compound interest can lead to increasing debts, savers can use it to their distinct advantage. The most relevant aspect of using compound interest strategically to increase your savings is to focus on the duration of your savings, because the longer they are held, the faster and greater the interest earnings.

Referring again to a theoretical example:

• Saver A opens a savings account with a £100 deposit and pays in £100 per month, from age 30 until they retire at age 60. They earn 10% compound interest calculated annually and end up with a balance of £208,029 based on savings contributions of £36,100.
• Saver B deposits the same savings into the same account, but starts saving ten years earlier. At age 60, their balance is £559,561 – an extra £351,532 in retirement funds, against additional savings deposits of £12,000.

This shows how, over time, compound interest can help savings grow exponentially,  and in this case, we can see why making an extra 10 years of contributions can make a dramatic impact, with the account earning interest of over £46,000 between years 39 and year 40 alone.

Of course, other factors will influence these outcomes, such as changing interest rates, inflation, and variations in contributions or withdrawals. Still, the principle stands: the longer you save, the greater your savings growth.

Harnessing the Power of Compound Interest

The benefit of compound interest is that it can make your money grow faster and continue gaining momentum the longer you save.

The illustrations we have explored look at annual interest for simplicity, but if that interest were calculated monthly, weekly, or daily, we can easily see how values can change considerably in a relatively short time.

Compounding is perfectly described as a snowball that rolls faster and with greater force the longer it is allowed to move without interruption. From an investment viewpoint, the gains can potentially be limitless.

Incorporating Compound Interest Accumulation Into an Investment or Savings Strategy

Intelligent investment relies on several tasks and evaluations, where investment advisers will, for example, evaluate interest rates, compounding periods, and contribution rates, and be able to forecast the point at which interest earned will begin to exceed the capital invested.

However, there is also a need to balance other factors, such as:

• Tax levies and the thresholds at which they may make a difference to net returns or profitability
• Risks, such as currency exchange rates and inflation
• The investor’s risk tolerance, and where the potential for losses counterbalances the appeal of lucrative interest rates

Compound interest, as we’ve said, is a straightforward concept, but it’s important not to underestimate the power of this financial calculation. Albert Einstein perhaps said it best: ‘Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.’

© Chase Buchanan Private Wealth Management.
Chase Buchanan Ltd is authorised and regulated by the Cyprus Securities and Exchange Commission with CIF Licence 287/15 and offers its services in the EU on a cross-border basis as per the provisions of MiFID.
Chase Buchanan Insurance Services, Agents & Advisors is authorised and regulated by the Cyprus Insurance Companies Control Service with License No 6883 and offers services in the EU on a cross-border basis as per the provisions of the Insurance Distribution Directive (IDD).

Investing in financial instruments involves risk and may not be suitable for all investors. The value of investments may go up as well as down and past performance is not a reliable indicator of future results. You may lose part or all of your invested capital.

*Information correct as at December 2025