It might sound like a riddle or a tongue-twister, but it’s fairly simple once you understand the concept. And it can make a big difference to the value of your savings over long periods of time, so it’s worth knowing about.
When you put money into a savings account, you can earn interest on your balance.
Interest rates are usually displayed as a percentage, referred to as an AER (Annual Equivalent Rate).
To work out how much interest you’ll earn, you can multiply the amount you have saved by your interest rate, displayed as a decimal, where 100% is 1.
Here’s an example:
If you left that money in your savings account – even without adding any more to it – you’ll be earning interest on a greater amount (AED 1,015) the next year. This is compound interest, and it can have a snowball effect on your savings.
| Year | Starting balance | Yearly interest earned at 1.5% AER | Closing balance |
|---|---|---|---|
| 1 | AED 1,000 | AED 15.10 | AED 1,015.10 |
| 2 | AED 1,015.10 | AED 15.33 | AED 1,030.44 |
| 3 | AED 1,030.44 | AED 15.56 | AED 1,046.00 |
| 4 | AED 1,046.00 | AED 15.80 | AED 1,061.80 |
| 5 | AED 1,061.80 | AED 16.04 | AED 1,077.84 |
| 10 | AED 1,144.44 | AED 17.29 | AED 1,161.73 |
| Year | 1 | 1 |
|---|---|---|
| Starting balance | AED 1,000 | AED 1,000 |
| Yearly interest earned at 1.5% AER | AED 15.10 | AED 15.10 |
| Closing balance | AED 1,015.10 | AED 1,015.10 |
| Year | 2 | 2 |
| Starting balance | AED 1,015.10 | AED 1,015.10 |
| Yearly interest earned at 1.5% AER | AED 15.33 | AED 15.33 |
| Closing balance | AED 1,030.44 | AED 1,030.44 |
| Year | 3 | 3 |
| Starting balance | AED 1,030.44 | AED 1,030.44 |
| Yearly interest earned at 1.5% AER | AED 15.56 | AED 15.56 |
| Closing balance | AED 1,046.00 | AED 1,046.00 |
| Year | 4 | 4 |
| Starting balance | AED 1,046.00 | AED 1,046.00 |
| Yearly interest earned at 1.5% AER | AED 15.80 | AED 15.80 |
| Closing balance | AED 1,061.80 | AED 1,061.80 |
| Year | 5 | 5 |
| Starting balance | AED 1,061.80 | AED 1,061.80 |
| Yearly interest earned at 1.5% AER | AED 16.04 | AED 16.04 |
| Closing balance | AED 1,077.84 | AED 1,077.84 |
| Year | 10 | 10 |
| Starting balance | AED 1,144.44 | AED 1,144.44 |
| Yearly interest earned at 1.5% AER | AED 17.29 | AED 17.29 |
| Closing balance | AED 1,161.73 | AED 1,161.73 |
Notice how the amount of interest you earn each year increases, even though the interest rate stays the same and you haven’t added any extra money.
The changes are small, but they grow exponentially year-on-year. Compound interest has a greater effect the longer you save for and the larger the amount you start with.
The key thing to remember about compound interest is the earlier you start saving, the more time it has to ramp up.
Even if you’re only putting away a small amount at first, it will start earning interest for future years.
If you can, it’s also a good idea to add money regularly to your savings account to keep your money growing.
Here’s another example of how your savings can grow, based on adding AED 500 per month to your initial AED 3,000 deposit with the same interest rate.
| Year | Starting balance | Total yearly contribution | Yearly interest earned at 1.5% AER | Closing balance |
|---|---|---|---|---|
| 1 | AED 3,000 |
AED 6,000 |
AED 94.28 |
AED 9,094.28 |
| 2 | AED 9,094.28 |
AED 6,000 |
AED 280.61 |
AED 15,280.61 |
| 3 | AED 15,280.61 | AED 6,000 |
AED 560.38 |
AED 21,560.38 |
| 4 | AED 21,560.38 | AED 6,000 |
AED 934.99 |
AED 27,934.99 |
| 5 | AED 27,934.99 | AED 6,000 |
AED 1,405.89 |
AED 34,405.89 |
| 10 | AED 61,281.66 | AED 6,000 |
AED 5,256.21 |
AED 68,256.21 |
| Year | 1 | 1 |
|---|---|---|
| Starting balance |
AED 3,000 |
AED 3,000 |
| Total yearly contribution |
AED 6,000 |
AED 6,000 |
| Yearly interest earned at 1.5% AER |
AED 94.28 |
AED 94.28 |
| Closing balance | AED 9,094.28 | AED 9,094.28 |
| Year | 2 | 2 |
| Starting balance |
AED 9,094.28 |
AED 9,094.28 |
| Total yearly contribution |
AED 6,000 |
AED 6,000 |
| Yearly interest earned at 1.5% AER |
AED 280.61 |
AED 280.61 |
| Closing balance | AED 15,280.61 | AED 15,280.61 |
| Year | 3 | 3 |
| Starting balance | AED 15,280.61 | AED 15,280.61 |
| Total yearly contribution |
AED 6,000 |
AED 6,000 |
| Yearly interest earned at 1.5% AER |
AED 560.38 |
AED 560.38 |
| Closing balance | AED 21,560.38 | AED 21,560.38 |
| Year | 4 | 4 |
| Starting balance | AED 21,560.38 | AED 21,560.38 |
| Total yearly contribution |
AED 6,000 |
AED 6,000 |
| Yearly interest earned at 1.5% AER |
AED 934.99 |
AED 934.99 |
| Closing balance | AED 27,934.99 | AED 27,934.99 |
| Year | 5 | 5 |
| Starting balance | AED 27,934.99 | AED 27,934.99 |
| Total yearly contribution |
AED 6,000 |
AED 6,000 |
| Yearly interest earned at 1.5% AER |
AED 1,405.89 |
AED 1,405.89 |
| Closing balance | AED 34,405.89 | AED 34,405.89 |
| Year | 10 | 10 |
| Starting balance | AED 61,281.66 | AED 61,281.66 |
| Total yearly contribution |
AED 6,000 |
AED 6,000 |
| Yearly interest earned at 1.5% AER |
AED 5,256.21 |
AED 5,256.21 |
| Closing balance | AED 68,256.21 | AED 68,256.21 |
As you can see, by year 10, you’re earning over AED 5,000 purely in interest – which you’ll then be earning interest on every year to come.
When you’re thinking about saving money, it’s important to consider the impact of inflation.
Inflation refers to price rises – including anything from bananas to property – so your money doesn’t go as far. For example, AED 10,000 could buy you a lot more 30 years ago than it can today.
If you’re worried about inflation eating away at the value of your savings, you could consider investing. After all, if the rate of inflation is higher than your interest rate, your savings are becoming worth less each year.
Like with interest on a savings account, the returns you can make through investing can compound into future years, but the growth potential is much higher.
But remember, stocks and shares can go both down and up in value, so you could get back less than you put in.
Explore: New to investing?
Compound interest doesn’t only apply to savings and investments – it can also apply to money you borrow.
From loans to credit cards, you could be subject to compound interest which means you’ll pay interest on the interest you’ve previously accrued. That’s why you should try to pay off interest-bearing debt as soon as you can.
Explore: Managing your debt
