Simple vs Compound Interest

Simple interest is the most straightforward way to calculate how your money grows. You earn the same fixed amount each year based only on your original deposit. It's like getting paid the exact same bonus every year, regardless of how much you've already earned.

With simple interest, Amy's £500 at 4% earns her £20 every single year $4$. After 3 years, she's earned £60 in total interest, giving her £560. The calculation never changes because you're always working with that original £500.

Compound interest works differently - it's interest earned on interest! This means your money grows faster over time because each year's interest gets added to your balance, and next year you earn interest on that bigger amount. It's like a snowball effect for your savings.

Joshua's example shows this perfectly: his £2000 at 2% compound interest grows to £2122.42 after 3 years. Notice how his interest payments increase each year (£40, then £40.80, then £41.62) because he's earning interest on an ever-growing balance. This extra £20.42 compared to simple interest might seem small, but over longer periods, compound interest becomes incredibly powerful.

Quick tip: Most real-world savings accounts use compound interest, so understanding this concept will help you make better decisions about where to put your money!