How Compound Growth Works, and What Wears It Down
By The Bureau of Wealth Team 1157 words
This article is general information, not financial advice. Consider your own circumstances or speak to a qualified adviser before acting on it.
Paying in twice as much can still leave you behind someone who started ten years earlier. Here's why, and the three things that erode the result.
Compound growth means the interest or investment returns you earn start earning returns themselves, so your money grows faster the longer you leave it. The strongest lever you have is time: starting a decade earlier can beat doubling your monthly contributions. Three things quietly wear the result down every year, though: inflation, charges and tax. What matters is the growth left after all three, and for UK savers the tax part is changing from April 2027.
This guide is for anyone saving in cash or investing through an ISA or pension who wants to understand what the projections really mean. The growth rates below are illustrations, not predictions. Investments can fall as well as rise.
Why time beats rate
Suppose you invest £250 a month and it grows at 5% a year. The compound interest calculator shows £208,064.66 after 30 years. You paid in £90,000; the remaining £118,064.66 is growth.
Start ten years later and the same £250 a month for 20 years reaches £102,758.42, under half as much. Try to catch up by doubling to £500 a month for those 20 years and you get £205,516.83. You've paid in £120,000, which is £30,000 more than the early starter, and you still finish behind.
The rule of 72 is a handy approximation: divide 72 by the growth rate to estimate how many years money takes to double. At 5% that's roughly 14 years. The first doubling you skip is the biggest one you lose, because it would have happened on top of everything else.
Don't worry much about how often interest is added. Savings providers may compound daily, monthly or yearly, and the difference is small. On £10,000 at 5% for 10 years, the calculator gives £16,288.95 with yearly compounding and £16,486.65 with daily, about £198 apart. Cut the rate to 4% with daily compounding and you get £14,917.92. Rate and time do the heavy lifting.
Inflation: the growth that isn't real
The Office for National Statistics reports that the Consumer Prices Index rose 2.9% in the 12 months to July 2026, and CPIH, which includes owner occupiers' housing costs, rose 3.1%. If prices keep rising at 2.9%, £10,000 held for a year would buy only what £9,718.17 buys today, according to the inflation calculator.
Over long periods it's much bigger. At an assumed 2.5% a year, the £208,064.66 pot above is worth about £99,193.30 in today's money after 30 years. That's why a projection in future pounds can look comfortable and still leave you short. Savers holding cash earning less than inflation are compounding in the wrong direction: the balance rises while its buying power falls.
Charges: they compound too
Fund and platform charges are usually a percentage of your whole pot, taken every year regardless of performance. A difference that looks tiny on a factsheet becomes large in pounds.
Using the investment fees calculator: start with £5,000, add £250 a month for 30 years at a 5% return before charges. With total charges of 1% a year you end up with £185,840.76. At 0.2% you end up with £216,811.68. That's a £30,970.92 gap on £95,000 of contributions. Compared with no charges at all, the 1% option costs £39,612.93.
Add up everything you pay: the fund's ongoing charge, the platform or account fee and any adviser charge. If you pay an adviser a percentage of your pot, work out what that is in pounds each year and decide whether the service is worth it.
Tax: what compounds is what you keep
Outside an ISA or pension, tax takes a slice of growth each year, leaving less to compound. According to HMRC's guidance on tax on savings interest, the Personal Savings Allowance covers £1,000 of interest for basic rate taxpayers, £500 for higher rate taxpayers and nothing for additional rate taxpayers. Interest above that is taxed, and HMRC has confirmed that savings income tax rates rise by 2 percentage points, to 22%, 42% and 47%, from 6 April 2027. Investment gains outside a wrapper face Capital Gains Tax above the £3,000 annual exempt amount for 2026 to 2027, at 18% or 24%.
ISAs remove that drag. For the 2026 to 2027 tax year you can put up to £20,000 into ISAs, and ISA interest doesn't count towards your Personal Savings Allowance. The ISA allowance calculator shows how much room you have left: someone who has paid £2,000 into a cash ISA and £3,000 into a stocks and shares ISA by 14 September 2026 has £15,000 left, or £1,875 a month over the 8 months to 5 April 2027. From 6 April 2027 the government has decided to cap cash ISA subscriptions at £12,000 a year for people under 65, with the overall £20,000 limit staying for other ISAs, so long-term cash savers may need to rethink where the rest goes.
| What wears growth down | How it works | What you control |
|---|---|---|
| Inflation | Cuts what each future pound buys | Don't leave long-term money in cash paying less than inflation |
| Charges | Taken from the whole pot every year | Compare total costs, not just the fund charge |
| Tax | Takes a share of growth outside a wrapper | Use your ISA allowance and workplace pension first |
When compounding shouldn't be the goal
Money you'll need within a few years, such as an emergency fund or a house deposit, shouldn't be invested for growth. A fall just before you need it can't be waited out, so easy access and FSCS protection matter more than return.
Compounding also runs in reverse on debt. Clearing a credit card or overdraft that charges a high interest rate gives you a guaranteed return equal to that rate, which investments can't promise. Pay those off before investing beyond what earns you employer pension contributions. And if you're within a few years of retirement, the 30-year examples overstate what's possible; a regulated financial adviser can help you balance growth against the risk of a late fall.
What to do next
- Next 10 minutes: enter your balance and monthly saving into the compound interest calculator, then rerun it starting five years later to see the cost of waiting.
- Today: find the total yearly charges on your ISA or pension and put them into the investment fees calculator.
- This week: check how much ISA allowance you have left for 2026 to 2027 and whether any interest you earn outside an ISA is above your Personal Savings Allowance.
Sources
- Office for National Statistics: Consumer price inflation, UK: July 2026
- GOV.UK: Tax on savings interest
- HM Revenue and Customs: Change to tax rates for property, savings and dividend income: technical note
- HM Treasury and HM Revenue and Customs: The Individual Savings Account (Amendment) Regulations 2026
