Compound interest

When you invest money, you earn interest on your capital. The next year, you earn interest on both your original investment plus the interest from the year before. Every following year the same happens – you earn interest on both your capital and the previous year’s interest. This snowball effect is known as compound interest. The ‘Rule of 72′ is a useful – though rough – shortcut to help you work out the effects of compounding. If you divide 72 by the percentage rate of growth, you get the number of years it takes for your investment to double. So it will take nine years for your capital to double at 8% a year, but only six years at 12% a year. Timing is crucial for getting the most out of compound interest. The earlier you start, the better it works. If you invest £100 a month from age 20 to 29 and then leave the cash alone to grow, you will have more money at the age of 60 than someone who saves £100 from the ages of 30 to 59.

• Watch Tim Bennett’s video tutorial: Compound interest: the lazy way to get rich.

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