In just a few days’ time, the eagerly awaited new Star Wars film, The Force Awakens, will open in the UK. Fans of the previous six instalments will be aware that the mysterious “Force” gives certain characters – Luke Skywalker and Darth Vader, to name but two – special powers such as telekinesis or being really good at lightsabre fighting. Until now, though, it’s never been quite clear how the Force actually works, and perhaps this is something the new movie will address.
Is there a comparably impressive force in the real world?
Well, perhaps there is: there is a story, possibly apocryphal, that Albert Einstein was once asked what he thought the greatest force in the universe was. To everyone’s surprise, the great physicist is reported to have said, “Compound interest.” As usual, though, Einstein had a point. For anyone who has money to put aside, compound interest over time can do amazing things – and fortunately we know exactly how it works.
Compound interest means that the interest your money earns then goes on to earn interest itself. Say you start with £1,000 in year one and you’re paid 5% interest a year: that means you make £50, so after 12 months you’ve got £1,050.
How compound interest works
In year two, however, you don’t just make another £50: the 5% interest is paid on the £1,050 so year two returns are £53, taking your capital to £1,103. This might not seem like a big difference – but over long periods of time, the power of this compounding is clear.
Let’s take a timeframe of 20 years: if we started with £1000 and made a fixed £50 a year, we’d end up with £2,000. But if annual interest of 5% was compounded, the final figure would be £2,653.
Over 30 years, instead of £2,653 we would have just over £4,320.
These calculations assume that we just left our original £1,000 untouched and didn’t deposit any more money. But if we could add an extra £20 a month, the results would be extraordinary: after 30 years, we’d have a pot worth over £20,500.
Maximising the force of the compound interest
There are several factors which dictate to what extent your capital will grow: of course, how much money you put in and how long you can leave it untouched is very important.
If you want to maximise the impact of compound interest, then, you need to look for the option that will give you the best yield. Peer-to-peer lending via Zopa, for example, is one investment that uses the force of compound interest to grow returns over the long-term, although capital is at risk.
If you are serious about improving your financial health, it’s time to use the force and our lending calculator is our helpful little tool to make the use of this powerful force.
We’re part of the wider sharing economy, so why not share this post with someone you know via the social buttons below.