Compound interest

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Not very educated around money but keep reading about compound interest. How do I take advantage of it? I have a S&S ISA, does that compound interest or do I need separate vehicle?

Compound interest simply means earning interest on your interest. So all you have to do is save for a longer period to get it.

What happens to the interest on your savings?

if it gets added to the amount you are saving and so starts to earn interest itself that’s compounding

I think !

If you play around with a compound interest calculator online it really is mind blowing.

I think about it at least daily 😂.

S&S ISAs don’t have interest, they are an investment so move up and down with the market.

Compound interest is when you have say £20,000 in a cash ISA or savings account at a rate of 4% interest. After one year, you will have £20,800 in that ISA. After another year, assuming no withdrawls a same interest rate, you will have £21,632 as you’re now getting 4% on the increased amount of £20,800. Year 3 is now 4% on £21,632, so you’ll have £22,497. And so on. So you’ve gone from £800 of interest in year 1 to £865 in year 3.

You don’t have to do anything to achieve it, it’s just what happens when your money is left in a savings vehicle that pays interest over time. Just don’t take the money out and you’ll benefit from compounding.

S&S ISAs are stocks and shares isas

Your question of will you get compound interest on a stocks and shares ISA. You won’t get compound interest but you will get compound growth.

The principle is the same, but you get compounding gains on the long term growth rather than the long term interest.

Following this as I'm also interested in how to actually do this! I think I read somewhere that this is why it's much better to invest in your pension earlier in your career?

If you play around with a compound interest calculator online it really is mind blowing.

that's what I have been doing so now I need to know where to save it 😁

@doodleschnoodle so do I need a cash isa?

That is a question way over and above anything to do with compounding. Generally, in the long term, stocks and shares outperform cash ISAs significantly, even with interest compounding as you get the same effect with a S&S ISA, just with return growth instead. But investing in S&S means your capital is at risk as investments can go up as well as down, and it is possible you can end up with less than you initially invested, although this is unlikely over a 5+ year period.

Why did you choose a S&S ISA? What are you saving for? When do you plan to spend it?

If your money is your emergency fund or to be spent in next few years than it’s likely a cash ISA is a safer bet as you won’t have to deal with market fluctuations. If these are longer-term savings, say 10-15 years, then a S&S ISA is highly likely to perform better, but there are no guarantees.

I’d recommend doing some reading on MoneySavingExpert so you understand it for yourself as I think this stuff is really important.

As pp says, you won't get compound interest on shares as they don't pay interest. You may get compound growth (as the value increases) or by reinvesting dividends. So if your equity investment grows 8% a year, you'll get 8% on the growing value- compounding just as compound interest does.

The question of shares or cash is more about your time horizons and approach to risk. If you can leave your money alone for 5+ years and not feel tempted to tinker with it, and you're well diversified, you will generally do much better in shares. Cash at the moment is only just beating inflation (and remember that inflation compounds as well).

@Cutleryclaire so is it better to increase my monthly contributions into my S&S isa or something else? My pension is a DB scheme & I do AVCs

@doodleschnoodle I chose S&S because it's for 20 plus years time. my short time savings are in PBs. My S&S has had good performance over the last 6 yrs.

If it’s long term savings then over a 20 year time frame stocks and shares generally out perform cash. If you are intending to use it as a lump sum of savings to fund something then you get closer to maturity you might want to start putting it into cash savings, or lower risk vehicles like bonds so you’re not exposed to market volatility.

It's just that if you re-invest what you earn on savings or investments that also then earns more the next year. If you just leave the lump sum, and take out the extra money you earned each year you will miss out on this, of course if you need the money generated to live on you may not be able to keep rolling it back in, but that is the ideal.

Then I would just carry on as is and as @HermioneWeasley says, when you get closer to needing access to the money, consider cashing in and putting it into cash savings instead so you aren’t subject to short-term market fluctuations hitting at the wrong time. You’re getting the compound benefits from your investments growing.

Thanks for all the advice. I will leave as is and just increase my monthly contributions. Just wanted to check I wasn't missing a trick.

PBs are not very good as savings, the rate you get is pretty low and unpredictable, although the chance of a big win is nice. I tend to use PBs as a back up fund as they are very easily accessible if you need a bit of money quickly, so you can keep your main savings in longer term fixed rate savings or other fairly inaccessible investments.

Compound interest is great and if you can get 4% or higher it’ll help

use a compound interest calculator to have a play around with figures

try £200 a month saving for 10 years,

then try on a lump sum

https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php

it doesn’t matter it’s in $ instead of £

you’d have nearer £30,000 of which £5k is interest - so money given to you for free after 10 years if the interest rate stayed at 4%

I’d never put all my eggs in one basket

@dogcatkitten I know PBs are crap, I have a little bit in a savings account but I thought it was preferably to use ISAs (higher rate tax payer)? Tbh I forget about the PBs,

@MikeRafone thanks I will take a look.

Do you think I should have a cash ISA then? My s&s ISAs savings goes into a few funds.

You need to allocate any money you have based on your personal circumstances and what your goals are.

Generally speaking having 3-6 months of expenses in cash is a good idea for an emergency fund. If you are saving up for a purchase in the next few years, such as a big holiday, car replacement etc then cash is likely best.

I personally have a 6 month cash reserve, sometimes I have to dip into it and then I will replace it. I pay 15% into my pension and my employer pays in 15%. I invest in my S&S ISA each month, usually a few hundred £ and this is based on a timeframe of 10+ years.

However, if you have high outgoings such as rent/ mortgage or you work in an industry that can be impacted hard in turbulent economic times then you might want to keep a larger cash reserve.

I ONLY keep cash as an emergency fund or if I'm saving up for something in particular. Cash over the long term is not going to build wealth due to the impacts of inflation. The way to build wealth over time is with assets and those assets include stocks and shares.

You absolutely CAN utilise compound interest within a S&S ISA. It's called a Money Market Fund. There are distributing funds (where the interest is paid out as a dividend so no compounding), and accumulation funds (where interest is reinvested in the fund and accumulates more interest - so compounding).

The advantages of these types of funds is they tend to attract a slightly higher rate than standard savings products; they are low risk investments, usually with very low fees, and they are very liquid assets so easy to access if you need the cash.
You might well find savings products that will return more, but these need monitoring as the interest rate drops after an initial bonus.

Money market accumulation investments are returning just over 5% at the moment. They can be a useful addition to an investment portfolio (depending on your financial goals).

Compounding interest and the concept of a passive income was one of the early things I taught my dc about finance.

Einstein 'Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it'

I can’t advise you on where to place your money. I though spread my money between ISA and stocks and shares so it spreads the risk