Simple Investing Interest
Understand 'interest'. Then you can understand the vital concept of 'return'

Interest is......
If you put 100 in cash in a deposit account at 6% per year you will get back 106 after one year. The extra £6 is called 'the interest on the account' or just 'interest'. 6% is the 'interest rate', and may be described as 'annual interest' or '6% per annum' - 'per annum' meaning the same as 'per year'.

Interest over shorter periods
It may be that interest is paid on the account each 6 months. In that case it might be described as 'interest at 3% half-yearly'. The word 'interest' does not mean anything without a period attached. If no period is mentioned it is assumed to be annual.

Simple interest
'Simple' here does not mean 'easy'. It is a technical term describing how interest is added to an account.

On your £100 deposit, 6% simple interest adds £6 to the account after one year, another £6 (making a total of twelve) after two years......a total of £30 after five years, £36 after six years........£60 after 10 years, and so on. The total in the account after 10 years is £160.

Simple interest is almost never used outside exams in Arithmetic. It's just a precursor to...

Compound interest
In real life, the £6 you earn on your £100 account is added to the balance to give an opening balance of £106 at the start of year 2. Your friendly bank will then calculate your 6% interest in year 2 on £106, giving £6.36. The interest you have earned over two years is not £12 but £12.36. This is described as '6% compound interest' or 'interest at 6% compounded annually over two years'.

In case you are bored by this, we will tell you that;

  • 6% simple interest over 20 years gives you 120% - £220 from every initial £100.
  • 6% compond interest over 20 years gives you 221%- £321 from every initial £100.

Quite a difference! More on this later.

Interest compounded over shorter periods
If interest is compounded half-yearly, the interest after 6 months is £3 and the interest in the second 6 months is 3% of £103, or £3.09. You can calculate that the interest in the third and fourth periods is £3.18 and £3.28 - a 2-year total of £12.55.

A cash deposit is quite a simple investment. For more complicated investments we use the word 'return' instead of the word 'interest'.

Learn about 'Return' now:  



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