Most of us will have heard the saying that time is money – a reminder not to fritter away our days. But did you know this maxim also applies to our personal finances? How, with a little planning and time, we can make an increasing amount of money on our money through savings.
The concept is simple. Compound interest is the interest paid on your original savings deposit and then the interest accumulated on the interest paid on the deposit. With a decent interest rate and years of saving, even initially small amounts can grow to produce significant gains over a lifetime.
Ramin Nakisa, co-founder of investment education service PensionCraft, likens compound interest to a snowball rolling down a hill. As the snowball gains momentum, it gets bigger. The longer, the better. “In mathematics, you call that an exponential rate of growth,” he says.
Put simply, compound interest means that £1 today will be worth more than £1 at a future date, due to its earning potential in the interim period. This formula – known as the “time value of money” – is used by banks and investment companies.
With compounding, whether you are investing or saving, the earlier you start the better. In an example given by Trading 212 − a financial platform for saving and investing − if someone aged 25 puts aside £5,000 a year* towards retirement but stopped aged 34, and then left their funds untouched but growing at 8% for the next 30 years, the effect of compounding would mean that their £50,000 was worth £787,000 by the time they turned 65**. By comparison, someone who put aside £5,000 a year on the same terms for 30 years from the age of 35, would only accumulate £612,000.
The principle also applies to other areas of your financial life, for instance, with how you manage debt – or if you even decide to take it on in the first place – and how this affects your savings.
“If you save more than you owe, compound interest switches suddenly from being something that hurts you [for example, if you’re paying interest on a credit card] to something that works in your favour,” says Nakisa.
For short- to medium-term financial goals, you probably don’t want to risk losing large chunks of your money by investing in the stock market. And it obviously won’t do to tie up your money in a high interest account long term.
For this kind of saving, a cash Isa may be ideal. The main benefit of a cash Isa is that, unlike other savings accounts, you don’t pay tax on the interest your money earns***.
You can open a cash Isa with many different types of financial organisations, including a bank, online fintech − financial technology − company, a building society or a stockbroker.
Cash Isas are a simple financial product. They are one of four types of Isa: the others being a stocks and shares Isa (which can include investing your money in company shares or investment funds); an innovative finance Isa, in which you earn interest on loans to individuals, businesses, or property developers; and a lifetime Isa, for saving to buy your first home or for later in life. To open a cash Isa, you must be aged 18 or over and a UK resident.
Every tax year, which runs from 6 April to the following 5 April, you can save up to £20,000 in Isas, either putting it all in a cash Isa or splitting your allowance across multiple accounts, whether a cash Isa or a stocks and shares one.
Your Isas will not close when the tax year finishes. You’ll keep your savings on a tax-free basis for as long as you keep the money in your Isa accounts.
When cash Isa interest rates are higher than the UK inflation rate (which was 2.2% in July ), you’ll see your money grow in real terms with minimal risk.
When shopping around for a cash Isa, you may want to look for one that pays the highest interest − the top ones currently offer about 5%. But you should also check whether a high interest cash Isa will give you easy access to your money, as many of those that offer the highest rates are subject to more restrictive conditions. The number of withdrawals you can make may be limited or you may not be allowed to put money back in once you’ve taken it out.
You can transfer all or part of the savings in your Isa from one Isa provider to another at any time. Just remember that, to keep the Isa’s tax-free benefits you must transfer your money between Isa providers − not, for example, from an Isa to a normal bank savings account.
Despite the twin benefits of compound interest and tax-free savings, cash Isas are still a minority pursuit for UK adults – especially young adults, with only about one in three saving into a cash Isa. But whether you’re lucky enough to be in the 18-24 age bracket or not, there’s never a bad time to start saving.
Visit the Trading 212 website for more detailed information on how to open a Trading 212 Cash ISA
Seek independent investment advice before entering into any financial transaction. When investing, your capital is at risk.
*Investment returns can go down as well as up and you may lose all your money.
**Illustration not indicative of future performance.
***Tax treatment depends on your individual circumstances and regulations, which may change.