Interest in Compound Interest

I am absolutely thrilled to tell you that I’ve had three really great questions about yesterday’s blog post on compound interest. I answered privately of course but it’s my absolute delight to rephrase them here for you so that we can all benefit.

How do I find a compound interest bank account in the UK?

They pretty much all are!

I’m sure there are some exceptions but it would be super duper rare. All you need to do to benefit from compound interest is make sure your interest is paid back into the account and leave it there.

That means that the next time the interest is applied, it’s based on your initial money and the interest you’ve already earned (plus any extra you’ve put in there).

Things to think about:

• If you don’t pay the interest back into the account it won’t be taken into account when they’re figuring the next interest, so it won’t be compounding.

• Bank accounts won’t say ‘this is a compound interest account’ but they will tell you how often the interest is worked out (might be daily, monthly, quarterly etc.) and they will display an AER rate (which we’ll talk about in a sec).

• Simple interest is much more likely to occur when you’re borrowing money than when you’re depositing or saving it.

What on earth is an AER rate?

It stands for the Annual Equivalent Rate and it was devised so that you can make comparisons between bank accounts which pay interest at different intervals. This is important because you will earn less on a bank account which pays interest once a year than one that pays interest daily even if they both offer 10% - and all because of compounding.

I’ve made a table which I hope will show you simply what I mean:

I guess that’s one of those things that it’s tempting to skip over - I get that.

The point is though, all of these accounts have a 10% interest rate (also known as the gross rate) but whether the interest is paid daily, monthly or yearly has a big effect on the actual result - so the AER lets you judge that without having to get stuck into the maths.

Notice that the AER on the account which is paid yearly is the same as the gross rate i.e. 10%. What the AER is doing is using maths to display what you can expect at the end of the year so it follows that if the interest is paid once at the end of the year then the AER will just show the basic interest rate.

That’s important because, without having to search for small details, if you’re looking at a bank account which shows the AER to be the same as the gross then you know they pay out once a year. If the AER is higher then you know it’s paid out more frequently. (You’ll want to dig a little deeper to find out exactly how often, but it’s a good starting point).

Cool huh? And nothing to panic over, just take time to be grateful that mathsy brains exist out there.

Does compound interest beat inflation?

Hmm. I’m going to go with no here.

For me, it’s not really anything to do with inflation. It’s to do with wealth creation in how powerful those exponential gains can be and also mindset, as in, are you prepared to make a good decision and then leave it be whatever is happening around you?

Whether or not the interest will beat inflation is entirely to do with whether the interest rate is higher than inflation, not whether it’s compounding or not. If inflation is 5% and your interest rate is 3%, well, it’s not beating inflation. If inflation is 3% and your savings are 5%, then it is and compounding only increases that.

I hope that’s answered some questions that might have come up for you.

Got more questions? Please ask away, it’s thrilling to give my brain cell something to gnaw on.

Love Eleanor. xxx