Note: Explainer video shared from investopedia's online content library
Let's start with an example. You invest £1000 into a savings account that gains 5% annually. After your first year, your initial savings grow by 5% to £1050. In your second year, your savings pot grows by another 5%, reaching £1103. If you keep earning interest at 5% over 30 years, your £1000 investment will be worth £4321. Et voila - the power of compound interest.
In layman terms, you earn interest on the original amount and on gains that you’ve made in previous years. Your interest is earning interest.
Compound interest is particularly beneficial to long term investors, and can be applied across any asset class so long as the gains stay positive.
When it comes to investing, being patient clearly pays off. Even Albert Einstein had this to say about compound interest:
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it".
If it’s good enough for Albert, it is good enough for us.